What is the Federal Estate Tax?

The Estate Tax and Why You Should Care

Taxes are a complicated matter for many people. They may dislike the fact they are being taxed, or simply not understand why Uncle Sam gets such a large cut of their hard earned money. Income tax is what most people think of when it comes to personal taxation, but the federal estate tax is another one to consider. Even if individuals may not ever be subject to such a tax, simply understanding it can help them better grasp the economy and general taxation.

A Simple Explanation of Estate Tax

In 2021 the federal estate tax lifetime exemption amount is $11.7 million. This means that, at your death, if your assets total less than $11.7 million you are not subject to estate tax; however, any assets above that $11.7 million cutoff may be taxed at a rate of 40%. Only people with an estate over the exemption amount will have an estate tax return filed after their death, and the return may not even be taxable due to deductions. According to the Tax Policy Center around 4,100 estate tax returns were to be filed for people who died in 2020 but only around 1,900 of those returns were likely even taxable. For married couples, there is a marital deduction which allows you to essentially pass all your assets tax free to your spouse, which will then be taxed upon his or her death).

So the question you’re probably asking is why does this impact me? Well, with the current administration, new tax policies are being proposed and the lifetime exemption amount could drop to $3.5 million. Under the proposed policy any amount over that lifetime exemption would be taxed at a 45% rate at least (with rates up to 65%). Simply put, someone with a $5.5 million estate would have $2 million taxed at a 45% rate.

In 2001, 109,600 estate tax returns were filed, of which 50,500 were taxable. The lifetime exemption that year was $675,000. While we likely won’t see an exemption that low, the proposed $3.5 million exemption amount and 45% estate tax rate would likely result in the number of taxable estates doubling or even tripling, growing similarly. Even if the proposed legislation fails to pass, the current lifetime exemption amount of $11.7 million will sunset at the end of 2025 reverting back to around $5.5 million.

Long-Term Capital Gains

Additionally, there is a proposal to alter the step-up in basis rule so that unrealized capital gains will be taxed at death. For example, if your father purchased 100 acres of land in 1960 for $10,000 and that land is now valued at $1,000,000, once you inherit it, you would have to pay capital gains tax (between 0-20% or possibly even higher with proposed legislation) – even if you don’t sell the property. Under the current rules, you would simply receive a “step up” in basis to $1,000,000 and avoid capital gains tax until the asset is actually sold. The step-up in basis allows for families of all wealth ranges to pass assets through generations and is a useful estate planning aspect.

Will This Impact Me?

The ultimate consideration here is that, if the proposed legislation passes in its current form, many more people will be subject to estate tax in the near future. Planning for estate tax could no longer just be for the ultra-high net worth individuals. One’s own demise is not something people like to discuss, but it is simply part of life. A good estate plan can help ease the worries involved in such a situation, and allow you to feel comfortable knowing all the bases have been covered in the event of your passing. Even those who aren’t subject to estate tax need to have proper planning. Life changes constantly. You may purchase a new home, become a parent or grandparent, or receive a large inheritance. Periodically revisiting your estate plan and will is advisable.

Check out our estate planning checklist here, more tax legislation proposals here, and more advice on if you need a will here.

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The information contained herein is provided for informational purposes, represents only a summary of the topics discussed, and should not be construed as the provision of personalized investment advice or an offer to sell or the solicitation of any offer to buy any securities. The contents should also not be construed as tax or legal advice.  Rather, the contents including, without limitation, any forecasts and projections, simply reflect the opinions and views of the author. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change without notice. There is no guarantee that the views and opinions expressed herein will come to pass.

This document contains information derived from third party sources.  Although we believe these third party sources to be reliable, Taylor Hoffman makes no representations as to the accuracy or completeness of any information derived from such third-party sources and takes no responsibility therefore.

Taylor Hoffman is not a Public Accounting firm, and the information contained herein should not be construed as tax advice. Rather the contents included are a reflection of the view and opinions of the author. There is no guarantee that the information provided fits every situation, and individuals should consult their tax advisor for more specifics.

Taylor Hoffman is not a law firm, and the information contained herein should not be construed as legal advice. Rather the contents included are a reflection of the view and opinions of the author. There is no guarantee that the information provided fits every situation, and individuals should consult their attorney for more specifics.

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