Estate planning is an unpleasant process, and so is dealing with the affairs of a loved one’s estate. But in order to get the full benefit of the gift your loved one leaves you, it’s important to be prepared for the taxes that gift will incur.
Most people are aware that taxes are owed on estate transference, but people tend to be foggy on the details until it’s too late to do anything about it. So how do you figure out what your tax liability will be, or what the tax liability of your loved ones will be on transference of your estate after death?
Read on to find out. (For related reading, see: Who Should Be Your Life Insurance Beneficiary?)
Estate Tax Basics
The high rate of federal estate tax — 40% — encourages many people to calculate their potential estate tax beforehand. It’s important to calculate how much you might owe in estate tax before something happens, rather than dealing with the consequences afterwards.
Estate tax is calculated on the federal and state level. Currently, more than 10 states have their own estate tax. These include: Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Tennessee, Vermont and Washington. The District of Columbia also has an estate tax.
The federal estate tax starts when the fair market value of your assets reaches $5.43 million. Each state has its own minimum on when the estate tax kicks in, ranging from $675,000 to $1 million. This means that you can be eligible to pay the state estate tax, the federal, or both. Because the estate tax is determined based on the current market value of your assets — not what you paid for them — determining that number is more complicated. (For related reading, see: How to Find an Estate Planning Lawyer.)
However, you don’t have to include any property you intend to leave your spouse or an eligible charitable organization. If you have any questions about the market value, see what it's being sold for.
How to Calculate
First, you’ll need to calculate the value of the gross estate. Debt, administrative fees, and assets that will be left to charities or a surviving spouse will be deducted from the total market value of those assets.
Then, you need to add any gifts. These include any gifts that fall above the gift tax exemption. The $5.43 million exemption includes gifts (it’s the government’s way of preventing people from giving away their fortune before their death to avoid estate taxes).
There are also online calculators that can help you do the math. Remember, these all just give an estimate. Depending how much you know about the value of your assets, your rough calculation can be fairly accurate or way off base.
The Bottom Line
If the loss of a loved one is looming, preparing for the tax burden of estate transference ahead of time can make the grieving process just a little bit easier. It can feel trivial to concern yourself with something like taxes in the wake of a personal loss, but for many people, focusing on the minute details of estate transference can be a comforting distraction. You can also prepare for taxes on your own estate to lessen the burden of the friends and family you leave behind. If you have other questions, you can talk to a CPA, CFP or tax lawyer to discuss your options in depth. (For related reading, see: You Just Inherited Money — Now What?)