What is an 'Estate Tax'

An estate tax is a tax levied on an heir's inherited portion of an estate if the value of the estate exceeds an exclusion limit set by law. The estate tax is mostly imposed on assets left to heirs, but it does not apply to the transfer of assets to a surviving spouse. The right of spouses to leave any amount to one another is known as the unlimited marital deduction, but when the surviving spouse who inherited an estate dies, the beneficiaries may then owe estate taxes if the estate exceeds the exclusion limit.

BREAKING DOWN 'Estate Tax'

Because the estate tax can be quite high, careful estate planning is advisable for individuals who want to leave significant assets to their beneficiaries or heirs without facing a lot of sales tax.

As of 2018, the Internal Revenue Service (IRS) requires estates with combined gross assets and prior taxable gifts exceeding $11.18 million to file a federal estate tax return and pay estate taxes. That means that an estate of $11 million would not be required to file a tax return, and would be exempt from paying an estate tax. For the two years prior, 2017 and 2016, the return and taxes were owed if the estate exceeded $5.49 million and $5.45 million respectively. 

Relationship Between Estate Tax and Gift Tax

While an estate tax is levied on an individual's assets and estate after death, gift taxes apply to funds given away while the taxpayer is living. Gift taxes prevent individuals with large estates from giving away all of their assets to their heirs during their lifetimes to avoid estate taxes. According to the IRS, the gift tax applies whether the donor meant the transfer as a gift or not. 

However, the IRS offers generous gift exclusions. As of 2018, the annual exclusion is $15,000, meaning tax filers can give away $15,000 to each and every person they select. If a tax filer wants to give the maximum gift to 10 people, for example, he can give away $150,000 without facing any tax penalties. in contrast, if he gives $20,000 to a single person, he has exceeded the exclusion by $5,000. When he dies, this sum is added to his estate when calculating his estate tax. 

The amount of the gift tax was raised from $14,000, the exclusion reported by the IRS prior to 2018. 

Difference Between Estate Tax and Inheritance Tax

An estate tax is applied to an estate before the assets are given to the beneficiaries. In contrast, an inheritance tax applies to assets after they have been inherited by someone. In the case of inheritance tax, each beneficiary may have to pay a different amount, depending on how much is inherited. Some states, including Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania, still have inheritance taxes.

Although laws vary, most states don't assess inheritance taxes on inheritances worth less than a certain amount, and they offer an exclusion on inheritances received from a spouse. In many cases, children who inherit assets from their parents are also exempt. In some cases, the rate of exclusion varies based on the heirs' relationship to the deceased. Some states such as Minnesota, Washington and Oregon have estate taxes.

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