Estate taxes are a complex subject, but understanding them is crucial for efficient financial planning. Here are some key aspects to consider.
Federal Versus State Estate Taxes
Estate taxes should not be confused with inheritance taxes. While estate taxes are levied on the total value of an estate, inheritance taxes are paid by the inheritors of the property. The first thing to know about estate taxes is that they are not the same across states. For instance, Oklahoma does not levy either inheritance or estate taxes.
The federal estate tax rate, however, can be substantial. The federal estate tax is levied on a decedent’s assets. The estate tax ranges from rates of 18% to 40% and generally only applies to assets over $13.61 million in 2024.
Federal Estate Tax Exemptions
The federal estate tax exemption significantly reduces estate tax liability. The federal estate tax exclusion exempts from the value of an estate up to $13.61 million in 2024. In addition,
“Portability” is a provision that allows a deceased spouse’s unused estate tax exclusion amount to transfer to the surviving spouse. The surviving spouse must timely file a federal estate tax return after the first spouse’s passing away and making the appropriate election.
However, be aware that the current exemption amount is scheduled to expire, or “sunset,” on December 31, 2025, unless Congress acts to extend it or make it permanent. If no action is taken, the exemption amount will revert to approximately $7 million per individual.
Limiting or Reducing Estate Tax
There are several strategies you can use to limit or reduce your estate tax. One popular method is annual gifting, which takes advantage of the gift tax exclusion to gradually reduce the size of your estate.
Another strategy is setting up an irrevocable life insurance trust (ILIT). This type of trust essentially removes the life insurance policy from your taxable estate. While the rules for establishing such a trust are stringent, it can help reduce estate taxes significantly.
However, like all financial strategies, it has its pros and cons. On the one hand, it can protect a large life insurance payout from estate taxes. On the other hand, it involves giving up control over your life insurance policy.
Estate taxes can be daunting, but with careful planning and understanding of the tax laws, you can ensure that your heirs receive the maximum possible benefit from your estate.
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