 Personal finance PowerPoint presentation, estate tax. Prepare to get financially fit by practicing personal finance. Support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Most of this information comes from Investopedia, Estate Tax, which you can find online. Take a look at the references, resources, continue your research from there. This by Julia Kagan, updated May 7, 2022. In prior presentations, we've been taking a look at estate planning, then focusing in on particular tools or components of estate planning, which may be applicable depending on your circumstances, this time that being estate tax. First question, what is an estate tax? An estate tax is a levy on estates whose value exceeds an exclusion limit set by law. Only amounts that exceeds that minimum threshold is subject to tax. So we'll go through a quick recap of the estate planning process. Obviously before death, the idea would be at the point of death. You have a couple goals. You want to be able to allocate your assets in accordance with your wishes. You want to be able to make things as easy as possible on your loved ones. And you want to be able to reduce the tax implications as much as possible, which in essence, reversed back to goal number one, being able to allocate your assets in accordance with your wishes, which of course you would think would be not given the money to the government if possible. The estate taxes then are going to be a tax at death. You might call it basically a death tax. The idea then being that you're going to be compiling the assets together for the individual at the point of death, which we're going to call the estate assets and liabilities. We're going to see how large that value is. And then we're going to compare that to an exclusion to see whether or not it's going to be subject in essence to an estate tax. So you would think then the estate tax would typically be applied to more wealthy individuals who when they die, they have a fairly substantial estate, which might be subject to the estate tax. Now remember the estate tax can be a little bit confusing in America. We typically think of the major form of taxation as an income tax, taxing earnings as we earn them. The estate tax, if applied, is kind of like a double tax because it taxes the earnings that have already been taxed on kind of a balance sheet side of things now at the point of death. So you've got to value the assets at that point in time, then see whether or not they're subject to the tax. Although there's an exclusion, so it's generally going to be assigned to more wealthy individuals. Okay. Assessed by the federal government and a number of state governments, so you could have state taxes as well in the United States, state estate taxes. So these levels are calculated based on the estate's fair market value, FMV, rather than what the deceased originally paid for the assets. So notice if you're trying to value the estate, you've got to determine on a balance sheet basis what point in time are you valuing it as? It's going to be somewhere around the date of death, right? And then you've got to reallocate or value what the assets are, which is easier said than done for some assets than the other. If you're talking about, say, stocks and bonds, for example, then you're not going to value it at what they paid for it. You're going to try to value it at the current market value, which you can look at the current stocks being traded. So it should be fairly easy to determine for some of those publicly traded stocks, for example. Other things can be more difficult, such as a home or jewelry, for example, because they may be unique in nature more difficult than to value as of the current point in time. But that's the idea. So the tax is levied by the state in which the deceased person was living at the time of their death. So how federal estate taxes work? Under what is known as the unlimited marital deduction, the estate tax does not apply to assets that will be transferred to a surviving spouse. So if you have one individual, it's a little bit more straightforward because obviously when they die, you could try to value their assets and tax them. If you have a married couple, you would think the definition of marriage would be two people now basically combined as one person legally speaking, you would think, and therefore if one of those individuals die, you would generally think the assets would convert to the other one or as one legal entity. And again, the definition of a financial legal entity may differ from state to state, whether they're community property or non-community property, but the general idea would be that the estate wouldn't really be taxed until the second person dies with regards to the estate tax, right? One person dies, the other person is still living, so you can think of it as their assets go into the other person or as one legal entity has not yet died because one person is still living and therefore when they die, that's when the estate tax takes place. Now that's good in terms of when one person dies, possibly not being subject to estate taxes at that time. However, when we think about how the estate taxes work, we usually think about an exemption, the exemption being similar to like a standard deduction for the income tax. So the estate tax is not really taking place until you clear the exemption, but for the standard deduction on an income tax, when you're married, they double the standard deduction as to when you're single. For the estate tax, you don't generally have that same kind of thing, so that means that if one spouse dies and all the assets go to the other spouse, when they die, they're going to have twice as many assets which are still subject to one individual kind of exemption. So then that's when planning could take place for using trusts or stuff like that to try to make sure that you're maximizing the exemption for both individuals in a married situation which we talked about in prior presentations. Okay, however, when the surviving spouse dies, who inherited an estate dies, the beneficiaries may owe estate taxes if the estate exceeds the exclusion limit, which is kind of similar to the standard deduction. The Internal Revenue Service IRS requires estates with combined gross assets and prior taxable gifts exceeding $11.7 million for 2021, $12.06 million for 2022 to file a federal estate tax return and pay estate taxes as required. So we're not talking about income here like an income tax. We're talking about kind of the asset value, the value of the estate on the balance sheet side of things that we got to value the estate and then determine if it's over these thresholds to see whether or not it's going to be subject to the estate taxes. Now, when you look at these thresholds, you might say, well, that's a pretty big number, not a whole lot of people are going to be subject to that and that's true, but also just realize with these estate planning, it's a long-term planning kind of thing. There's a couple things you want to keep in mind here. One is even when we put in the federal income tax, we thought it was only going to be applied to very wealthy individuals and obviously like middle income individuals are clearly subject to the federal income tax. And then on the estate tax, we really thought that that would only be applied to really well-off individuals, which you're thinking generally at this point would be like billionaires, you would think. And the $12.06 million is still pretty far away from a billion. So it's far away from the billionaire kind of status. Also, just note that as time passes, there's going to be inflation that's going to eat into that, so that number might not look quite as large. Also, when you're doing long-term estate planning, you also got to take into consideration that threshold can change drastically based on whoever's in the political power at any given time. So you can't just depend on that number as if it's going to stay static because you don't know when you're going to die and you don't know what the number will be. When you die, it can change drastically just depending on whoever's in political power at the time. Just a couple things to consider. In many instances, the effective U.S. estate tax is substantially lower than the top federal statutory rate of 37%. This discrepancy happens partially because the tax is assessed only on the portion of an estate that exceeds the exclusion. So the exclusion, kind of like a standard deduction, you're paying taxes on the amount that's over and above the exclusion. To illustrate the impact of the exclusion, consider an estate that's worth $13 million. With the 2022 exclusion limit of $12.06 million, federal estate taxes would be owed on $940,000 of the estate or less than a tenth of its total assets. In 2022, the rate is 40%. So that tax bill would be $376,000. In addition, state holders and beneficiaries or their attorneys continually find new creative ways to protect significant chunks of a state's remaining value from taxes by taking advantage of discounts, deductions, and other legal structures. So obviously, you're going to have a lot of debate over what the estate tax, how effective it is and whether or not it's a good thing or a bad thing. Clearly, this threshold or this limit in terms of what the exclusion will be will have a big impact. Obviously, as we lower that threshold, some people would argue, well, that's good because it's still on fairly wealthy individuals and we need to get more money and so on on the estate taxes. But also, that will give incentives for more people to try to do estate tax planning, which as we've seen in prior presentations, gets more and more complex using complex structures such as trusts, which can get to a degree of complexity where you don't even really know who owns what. And it also creates a whole industry of lawyers and whatnot that are doing things in order to deal with this estate taxes, which you would think, like if you didn't have that there, they might be applying their considerable skills and efforts to other areas and whatnot. It's an interesting area of law and taxation to be in, but there's pros and cons related to it. In any case, how estate taxes work and a state that exceeds federal tax may still be subject to taxation by the state where the deceased person was living at the time of their death. So we also have the state estate taxes as opposed to federal estate taxes, possibly depending on the state you're living in, if you're in the United States. That's because the exemptions for state and district estate taxes are only a fraction of those of the federal exclusion that said, estates valued at less than $1 million are not taxed in any jurisdiction. So jurisdictions with estate tax, and let's just quick look at the state side of things for the estate taxes. So here are the jurisdictions that have estate taxes with the threshold minimums at which they apply showing in parentheses. So we got Connecticut, $1,100,000, District of Columbia, $4,254,800. This being the exemption, so if you're over that threshold, possibly subject to the estate taxes for that locale. Hawaii, $5,490,000, and again this is the state's, in addition to whatever you might be subject to on the federal side of things, which we talked about earlier. So Illinois, $4,000,000, Maine, $6,010,000, Maryland, $5,000,000, Massachusetts, $1,000,000, Minnesota, $3,000,000, New York, $6,110,000, Oregon, $1,000,000, Rhode Island, $1,648,111. It's a funny number, it's probably because it's going up with inflation or something. Vermont, $5,000,000, Washington State, $2,193,000. Above those thresholds, the taxes usually assessed on a sliding basis, much like the brackets for income tax in 2021. The tax is typically 18% or so for amounts just over the threshold and rises in steps usually to 39%. So in other words, these numbers are kind of like, you can think of them as the equivalent of kind of like the standard deduction for income taxes applied to the state exemption amounts for the estate taxes over that amount. That's the amount that could be subject to taxation possibly. And then you've got the progressive tax system in a similar way possibly to the income taxes, meaning the amounts that are on the lower income or asset value side are going to be taxed at lower amounts. And as your estate value goes up possibly being subject to higher rates. So some states such as Massachusetts offer tax rates as low as 0%, depending on the taxable size of the estate. The relationship between estate tax and gift tax. So since estate taxes are levied on the individual's assets and estates after death, they can be avoided if you gift assets before you die. So remember the interplay that's going to happen here, it gets quite complex, right? If someone says, hey, I'm going to take your money when you die, right? What are you going to do, right? When you die, you're going to try to give all your money away to your son or daughter, most likely on your deathbed so that you don't have any money for them to take when you're actually dead. So then the person that wants to take your money, the government, doesn't like that. So they're going to say, well, no, you can't give your money away on your deathbed. We're going to make rules with regards to the gifting of money and tie those rules to the estate tax in some way, and then the merit go round, goes round and round, and it gets complicated. So however, the federal gift tax applies to assets that are given away in excess of certain limits while the taxpayer is living. According to the IRS, the gift tax applies whether the donor met the transfer as a gift or not. So then the question also becomes, well, was it a gift or not? Well, if you gave some money to someone else, did you get something in return? Was it a market transaction? Or if you didn't get anything in return, you would think it would basically be a gift, right? That would be the general idea. So gift tax exclusion. However, the IRS offers generous gift tax exclusions. For 2021, the annual exclusion is $15,000, meaning tax filers can give up to 15,000 to each person they wish without paying tax on any of those gifts. So now you've got a threshold in terms of how much you can give away per year in an attempt to limit how much you can give away, like in one year, like right before death or something like that would be the general idea. So if, you know, 15,000 is a decent size number, but when you compare it to like a multi-billion dollar estate or something like that, it's not quite significant with regards to, you know, the overall billion dollars, right? So the ratio, you know, so in any case, so that would be taken into consideration with the estate planning. For 2021, the annual exclusion is 15,000. For 2022 tax year, the annual exclusion is $16,000. And again, note that that 16,000 isn't the total gifts you can give. That's the gifts on a per person basis to give multiple persons up to the limit of the 16,000 would be the general idea. And they may offer gifts up to the value of the gift exclusion year after year without incurring tax. So now the idea, if you're trying to lower the amount of tax as you're going to have for the estate tax, you've got to lower your actual estate. One way you can do that is try to give money away while you're alive in such a way that you're not going to be subject to taxes, which means that you could start giving money away of the 16,000 to multiple individuals. As many individuals that you would want up to the, basically the 16,000 would be the idea. The other thing you could start to imagine is, well, what if I gave money away, quote, gave money away to like a trust, like a separate entity and a trust, and that's where, you know, creative, other creative strategies can basically take place. So these provisions make gifting an effective way to avoid tax on assets transferred to people such as non-family members who might be subject to the estate tax if the assets were transferred as part of an estate gift exclusion limit. If your gifts exceed the gift exclusion limit, they aren't subject to tax immediately and may never be taxed unless your estate is substantial. So now you're going to say, well, what if I go over that amount? Well, then you've got to note that you've gone over that amount, but it's kind of tied still to the estate tax because you can basically think of it as kind of eating into your exemption limit for the estate tax. So the amount above the gift limit is noted and added to the taxable value of your estate when calculate a state tax after you die. For example, let's say you decide to make a gift of $76,000 in 2022. So since the annual exclusion is $16,000, you'll be spared tax up to that number. The remaining $60,000, however, will need to be reported on a 709 gift tax return. So you're filing the gift tax return 709 to report the fact that you've given amounts over the limit to an individual. That $60,000 will reduce your lifetime exclusion to $12 million, meaning when you die and you have your estate then you've got your exemption. You've cut into your exemption amount there. And so that means that if your estate is over the $12 million now, you could be subject to the estate taxes at that point. And also your estate tax exclusion to $12 million. So estate taxes versus inheritance tax. An estate tax is applied to an estate before the assets are given to beneficiaries in contrast, and inheritance tax applies to assets after they have been inherited and are paid by the inheritor. So notice we in the United States, we usually think of the first tax as like an income tax, meaning when you get money. That's usually when the taxation happens. And we have the estate tax too, which is a little bit confusing to us here because that means you're kind of taxing the person who died's balance sheet instead of the income statement side of things. And you've got to value the things and then tax basically the balance sheet as opposed to saying, and it kind of would make more sense from an income tax side or an income tax system to say, well, when the money goes to somebody else, now that's income to them, and you would think that it would be subject to the income tax at that point in time. But that would have different implications because if it's an estate tax, you're trying to value the entire estate, you know, put it all together and you're taxing this one lump kind of value on the balance sheet side of things. If it's an inheritance tax, then you could have, you would have strategies when the person receives the money and people would try, you could try different tax strategies to give different people different amounts of money and use trusts in different ways so that so that when they receive the money, you know, different people are going to receive different proportions of the total estate and possibly be subject to the tax if you had an inheritance tax. So how an inheritance tax works, there is no federal inheritance tax. An inheritance tax, however, and only select states, Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania, still have their own inheritance taxes. So when you're talking on the federal side of things, we're usually thinking in the United States, the estate taxes on the inheritance tax, you could have differences in terms of the state that you are in with regards to how they may conduct their estate taxes. Maryland alone has both an estate and inheritance tax. So you would think that normally you wouldn't have both of those two things because you're taxing it kind of twice if you tax it on the balance sheet side and then when it gets distributed to the person that receives it, but Maryland apparently has that. So the inheritance tax is assessed by the state in which the inheritor is living, whether your inheritance will be taxed and at what rate depends on its value, your relationship to the person who passed away and the prevailing rules and rates where you live, as with a state tax, an inheritance tax, if due, is applied only to the sum that exceeds the exemption. So you have a similar kind of process because now you'd get the money which you would think you might cover like on the income tax, like kind of if it was a federal like kind of on your 1040, but you might have a separate kind of thing where you're basically getting kind of income which we're defining now as inheritance, obviously, and then applying the rate when you receive the money. So above those thresholds, part of the problem with this, of course, is that when you receive the income, if it was an inheritance and you have a progressive tax system as we do in the United States, then when you get that lump sum money, that would bump you up into a higher tax bracket and a lot more of it would be taxed and so on and so forth. So it gets quite complicated. But in any case, above those thresholds, the taxes usually assessed on a sliding basis, rates typically begin in the single digits and rise to between 15 and 19 percent. The exemption you receive and the rate you're charged may vary by your relationship to the deceased. Inheritance tax exceptions. So life insurance payable to a named beneficiary is not typically subject to an inheritance tax. So life insurance is not generally considered, you know, an inheritance life insurance. Although life insurance payable to the deceased person or their estate is usually subject to an estate tax. As a rule, the closer your relationship to the decedent, the lower the rate you'll pay. Surviving spouses are exempt from inheritance tax in all six states. Domestic partners too are exempt in New Jersey. Descendants pay no inheritance tax except in Nebraska and Pennsylvania. Jurisdictions with inheritance tax. Here are the jurisdictions that have inheritance taxes with their threshold minimums shown in parentheses. You got Iowa, 25,000. Kentucky, 500 to 1,000. Maryland, 50,000 to 100,000. Nebraska, 10,000 to 40,000. New Jersey, none to 25,000. And Pennsylvania, none to 3,500. Because the rates for estate tax can be quite high, careful estate planning is advisable for individuals who have estates worth millions of dollars that they want to leave to heirs or other beneficiaries. So if you have a substantial amount in the estate, then it could be worthwhile to go through the rig of a role of doing the estate tax planning strategies.