Estate taxes: Who pays, how much and when

Benjamin Franklin famously noted that only two things are certain: death and taxes. An estate tax combines them both. Sometimes referred to as a “death tax,” this federal tax is levied on the transfer of assets once an individual passes away. 

How does estate tax work?

Imagine that at death, all the assets you own or have an interest in are captured in a snapshot. Regardless of where they’re located, those assets make up your gross estate for federal estate tax purposes.

In 2024, the Internal Revenue Service (IRS) levies a federal estate tax on individuals having assets with a fair market value of $13.61 million or greater at their death. The IRS considers estate assets to be any interest in real estate, such as a home. Other examples of assets include, but are not limited to:

• Stocks and bonds
• Cash
• Interest in life insurance or annuity contracts
• A 401(k) or other retirement accounts
• Personal property, such as a vehicle, clothing or household furnishings

If the decedent’s estate plan leaves their assets to their spouse, an estate tax may not be due. An unlimited marital deduction allows an unrestricted transfer of assets between spouses. However, any assets owned by the surviving spouse at their time of death will be included in their taxable estate, including previously exempted amounts. Assets distributed to a qualified charitable organization may pass free of estate tax.

How much is estate tax?

Current federal estate tax rates put in place in 2017 by the Tax Cuts and Jobs Act (TCJA) range from 18% to 40%. However, the estate tax exemption amount, currently $13.61 million per individual, is scheduled to “sunset” at the end of 2025 and revert to pre-TCJA levels, which is an estimated $7 million per individual (adjusted for inflation). The maximum federal estate tax rate will remain 40%.

The estate tax exemption sunset could reduce the amount that an individual passes on tax free. As a result, now is a good time to make plans to transfer wealth to heirs and charities.

Are there state estate taxes, too?

In addition to federal estate tax, your assets may be subject to state estate tax if you reside in a state that imposes this tax. Keep in mind that your assets could be subject to state estate tax even if your estate isn’t worth the current federal estate tax filing limit of $13.61 million at the time of your death.

Currently, 12 states and the District of Columbia charge estate taxes, which are paid in addition to any federal estate tax. The exemption levels vary and can reach as high as $13.61 million. The state estate tax is generally charged based on the state an individual resides in at the time of their death. However, other factors, such as owning physical assets outside of your home state, could give rise to additional state estate tax liability.

When are estate taxes paid?

Federal and state estate taxes are paid from the assets of your estate before the remaining assets can be distributed to your heirs. The executor or the trustee, as applicable, is responsible for filing the required federal and state estate tax returns and ensuring that all taxes are paid from the estate. After confirming no additional liabilities exist, the executor or trustee will distribute the remaining assets to the named beneficiaries.

The federal estate tax return, Form 706, is due nine months from the decedent’s date of death and can be extended an additional six months. If an estate tax payment is due, the estate tax payment should be made on or before the original filing deadline for the return unless a request for an extension to pay has been granted by the IRS.

The IRS can take up to three years to let an executor or trustee know whether they have accepted the return as filed or if they will audit the return. An audit of the estate tax return may result in additional estate taxes being assessed. It’s not uncommon for several years to have passed before the executor or trustee receives a final assessment from the IRS.

What’s the difference between estate tax and inheritance tax?

An inheritance tax is another type of death tax and is paid by the beneficiary, not the estate. It’s charged at the state level and is assessed by the state a person resides in at the time of their death. Currently, just six states levy an inheritance tax. Maryland is the only state that charges both an estate tax and an inheritance tax.

Inheritance tax is based off the relationship of the deceased to the person receiving the assets. Beneficiaries who are closer to the deceased, such as a spouse or children, tend to pay a lower tax rate than someone who's more distant, like a friend or a cousin.

Gift tax vs. estate tax

Each year, individuals can make a gift up to the annual gift tax exclusion limit, without having to pay gift tax or file a federal gift tax return. The limit in 2024 is $18,000 per recipient. Amounts above this cap are considered taxable gifts and must be reported on a gift tax return, which is due the following calendar year.

Gift tax does not apply in certain circumstances, including:

• Qualified gifts made to your spouse, contributions to a political organization or to a qualified charitable organization.
• Qualified medical or education expenses paid directly to the educational or medical provider.

How to reduce estate taxes

High net worth individuals subject to estate taxes can take steps to minimize their tax burden. Here are options to discuss with your wealth advisor:

• Annual gifts. Take advantage of the annual gift tax exclusion to reduce your overall estate value.
• Leave funds to charity. An estate planning attorney could draft a plan that eliminates or reduces estate taxes by giving the amount above what can be sheltered from estate tax to a qualified charity. Outright gifts to charities may be eligible for the unlimited charitable deduction and can allow you to fulfill both your philanthropic goals as well as to minimize estate taxes.
• Set up an irrevocable trust. You can establish an irrevocable trust for others during your lifetime. While you will relinquish control of the assets and pay gift taxes on your contribution to the trust, the assets will be outside of your estate and any income or appreciation will go to the named beneficiaries. 

You can also make lifetime gifts into an intentionally defective irrevocable trust. In this situation, the individual who sets up the trust, or grantor, pays income taxes on any revenue generated by the assets, ensuring that trust assets are not used to pay taxes and enhancing the growth potential of the trust assets.

The current transfer tax exemption scheduled to sunset in 2025 could reduce the amount an individual is able to fund into an irrevocable trust free of the estate tax, so now may be an opportune time to establish a trust that transfers wealth outside of your estate. For example, setting up a Spousal Lifetime Access Trust (SLAT) could allow one spouse to gift assets to another spouse in trust, or both spouses to gift assets to each other, letting the beneficiary spouse access the assets while removing them from their taxable estate.

• Use an irrevocable life insurance trust (ILIT) policy. You can establish a trust that will own an insurance policy on your life. You’ll make contributions to the trust periodically. The trust uses those funds to pay premiums on the insurance policy and, at death, the proceeds are exempt from estate taxes as long as the trustee adheres to all the requirements that the IRS has in place during the lifetime of that trust.
• Pay for educational or medical expenses from the estate. These distributions are exempt from annual exclusion gift tax requirements only if the funds go directly to the provider.

If your net worth is nearing or over the current estate tax threshold, either for federal or state taxes, work with a wealth advisor to help you determine which tax minimizing strategies are right for you.

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