Estate Tax 101: Everything You Need to Know!
As you start your estate planning, you must consider estate taxes as part of the process. Although not everyone is subject to this tax, it is important to understand the basics of estate tax to avoid surprises in the future. In this article, we will give you everything you need to know about estate tax.
What is Estate Tax?
Estate tax, also known as inheritance tax, is a tax levied on the transfer of the estate of a deceased person. This tax is imposed on the transfer of property from the deceased person to their beneficiaries. The federal government and some states levy estate tax, and the tax amount is based on the total value of the estate.
Who is Subject to Estate Tax?
Not everyone is subject to estate tax. In 2021, the federal estate tax exemption is $11.7 million per person. This means that the first $11.7 million of an estate is exempt from federal estate tax. However, if the total value of the estate is more than $11.7 million, the excess amount is subject to estate tax at a rate of 40%.
For example, if an individual’s estate is valued at $13 million, the federal estate tax will be imposed only on the $1.3 million that exceeds the exemption limit. Therefore, the estate tax will be $520,000 (40% of $1.3 million).
It is essential to note that some states also impose estate tax. These states have their own exemption limits that differ from the federal exemption limit. Make sure to check your state’s estate tax laws to determine whether you are subject to the tax and what the applicable exemption limit is.
How is Estate Tax Calculated?
As mentioned earlier, estate tax is calculated based on the total value of your estate. This value includes everything you own, such as real estate, investments, bank accounts, retirement accounts, life insurance policies, and personal property.
To determine the total value of your estate, you will need to carry out a detailed inventory of all your assets and their respective values. You will then subtract any liabilities you owe, such as mortgages, loans, and outstanding taxes. The remaining amount is known as your net estate value.
If your net estate value exceeds the exemption limit, the excess amount is subject to estate tax at a rate of 40%.
How can you Reduce Estate Tax?
Although estate tax cannot be entirely eliminated, there are ways to reduce it. Here are some estate planning strategies that can help reduce estate tax:
1. Gifting: You can gift assets to your beneficiaries during your lifetime. This can help reduce the value of your estate, making it exempt from estate tax.
2. Charitable donations: Making donations to charitable organizations reduces the total value of your estate, reducing your estate tax liability.
3. Trusts: Establishing a trust allows you to transfer assets to your beneficiaries while retaining some control over them. This can help reduce the value of your estate, reducing your estate tax liability.
4. Life Insurance: Life insurance policies can provide your beneficiaries with funds to pay estate taxes without selling off assets.
Conclusion
In summary, estate tax is a tax levied on the transfer of property from a deceased person to their beneficiaries. The federal estate tax exemption limit is $11.7 million, meaning the first $11.7 million of an estate is exempt from federal estate tax. The excess amount is subject to a 40% tax rate. Some states also impose estate tax, and it is essential to check your state’s estate tax laws to determine whether you are subject to the tax. Estate planning strategies such as gifting, charitable donations, trusts, and life insurance can help reduce estate tax liability. Always consult with a tax professional to ensure that your estate planning strategies align with the law.
With this knowledge, you can plan your estate effectively and reduce the impact of estate tax on your beneficiaries, allowing them to receive their inheritance with ease.