What Are Death Taxes? How to Reduce or Avoid Them

What Are Death Taxes?

Death taxes are taxes imposed by the federal and some state governments on someone's estate upon their death. These taxes are levied on the beneficiary who receives the property in the deceased's will or the estate which pays the tax before transferring the inherited property.

Death taxes are also called death duties, estate taxes, or inheritance taxes.

Key Takeaways

  • Death taxes are taxes on a deceased's estate imposed by a government.
  • Death tax is another term for estate and inheritance taxes.
  • Death taxes generally only apply to estates and inheritances over a specific value. In 2023, an estate must have assets of over $12.92 million to be subject to federal taxes. In 2022, the number was $12.06 million.

Understanding Death Taxes

A death tax can be any tax imposed on property transfer after someone's death. The term “death tax” gained popularity in the 1990s and was used to describe estate and inheritance taxes by those who wanted the taxes repealed. In estate taxes, the deceased’s estate pays the tax before the assets are transferred to a beneficiary. With the inheritance tax, the person who inherits the assets pays.

The estate tax, charged by the federal government and some state governments, is based on the value of property and assets at the time of the owner's death. The federal estate tax ranges from 18% to 40% of the inheritance amount

Twelve states impose a state estate tax separate from the federal government. These states are Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia.

The federal government does not impose an inheritance tax, but several states do—Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania; however, in all of these states, property passing to a surviving spouse is exempt from inheritance taxes. Nebraska and Pennsylvania impose taxes on property passing to a child or grandchild in some instances.

Death Tax Thresholds

Most people end up not paying the death tax because it applies to only a few people. This is because the 2017 Tax Cuts and Jobs Act applied the estate tax to the basic exclusion amount, which in 2022 is $12.06 million and in 2023 is $12.92 million.

The Tax Cuts and Jobs Act expires after 2025. The basic exclusion amount is set to drop back down to pre-TCJA levels if Congress doesn't renew the act.

For example, assume an individual leaves an estate valued at $12.8 million (accounted for inflation) in non-exempt assets to the children and has never left any gifts that exceeded the exclusion amount. The amount above the federal level in 2022 ($12.8 million – $12.06 million), $740,000, will be subject to estate tax. According to the Unified Rate Schedule, the taxable amount is subject to a 37% tax plus a base tax of $155,800. Therefore, the estate will have a death tax liability of (37% x $740,000) + $155,800 = $429,600.

So, if a decedent's estate is valued at less than the applicable exemption amount for the year of death, the estate won't owe any federal estate taxes.

Unified Tax Credit

The unified tax credit has a set amount that an individual can gift during their lifetime before any death taxes or gift taxes apply. The tax credit unifies both the gift and estate taxes into one tax system, decreasing the tax bill of the individual or estate, dollar to dollar.

Since some people prefer to use the unified tax credits to save on estate taxes after their deaths, the unified tax credit may not be used for reducing gift taxes while still alive. It may instead be used on the inheritance amount bequeathed to beneficiaries after death.

Unlimited Marital Deduction

Another provision available to reduce death tax is the unlimited marital deduction, which allows an individual to transfer an unrestricted amount of assets to their spouse at any time, including at the death of the transferor, free from tax.

The provision eliminates both the federal estate and gift tax on property transfers between spouses, in effect treating them as one economic unit. The transfer to surviving spouses is made possible through an unlimited deduction from estate and gift tax that postpones the transfer taxes on the property inherited from each other until the second spouse’s death.

The unlimited marital deduction allows married couples to delay the payment of estate taxes upon the death of the first spouse because after the surviving spouse dies, all assets in the estate over the applicable exclusion amount will be included in the survivor’s taxable estate unless the assets are used up or gifted during the surviving spouse's lifetime.

Advantages and Disadvantages of Death Taxes

  • High threshold

  • High tax revenue

  • Double taxes

  • Loopholes

Advantages Explained

  • High threshold: The death tax is triggered when estates are valued at more than $12.06 million in 2022 and $12.92 million in 2023, so only the very wealthy need to be concerned about it.
  • High tax revenue: In 2020, tax revenues to the government from federal estate and gift taxes equaled $17.6 billion, with projections increasing to nearly $50 billion by 2031.

Disadvantages Explained

  • Double taxes: Those whose estates are large enough to trigger death taxes will be taxed twice—once with income taxes and once with the estate tax.
  • Loopholes: There are ways to avoid paying estate taxes, so it is natural for those who have the assets to use these loopholes to avoid paying them.

How to Reduce or Avoid Death Taxes

Most people will not need to worry about death taxes because not many have more than $12 million in assets. This number may drop after 2025 if Congress doesn't renew the Tax Cuts and Jobs Act, but the figure could still be $5 million or more—more than most people have.

If you do happen or expect to have enough assets to trigger death taxes, there are some things you can do to reduce or avoid them:

  • Create an irrevocable trust: You may be able to place your assets in an irrevocable trust to shield them from estate taxes. You could then have the trust distribute the funds to you and your beneficiaries as income, reducing your tax burden. The most common trust used in this tactic is a grantor retained annuity trust (GRAT).
  • Give your assets to family and friends: You can give them away to relatives and friends tax-free as long as you don't exceed the lifetime exclusion limit of $12.06 million ($24.12 million if you and your spouse give them away) in 2022 and $12.92 million ($25.84 million if you and your spouse give them away) in 2023.
  • Enjoy your money: The best way to avoid estate taxes is to ensure you give enough away so that your family won't struggle, then go out and enjoy the money you've worked hard for.
  • Charitable donations: Giving away money to charitable organizations you believe in can be rewarding—you can also deduct contributions from your estate.

How Do You Avoid Death Taxes?

Most people will not incur estate taxes, commonly called the death tax. But if you have $12.06 million or more in assets in 2022 or $12.92 million in 2023, you can avoid paying taxes by donating to charity, giving enough of your estate away to reduce its value, or placing it in special trust funds.

What States Have Death Taxes?

Twelve states and one district have estate taxes—Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia.

Are There Death Taxes in the U.S.?

The federal government and 12 states have tax laws that impose taxes on estates with significant assets.

The Bottom Line

The death tax is a tax on a person's estate after they have passed. Also known as estate taxes, to be triggered, the estate must have significant assets—more than $12.06 million in 2022 or $12.92 million in 2023. Most people will not need to worry about a death tax, but for those that do, there are some tactics you can use to reduce or avoid the tax.

Article Sources
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