What is Estate Tax?

Benjamin Franklin once wrote that death and taxes are the only things certain in life. When it comes to estate tax, some people experience both! What is estate tax? In this blog post, we’ll explain the essentials of the estate tax, exploring its definition, purpose, and key considerations for those navigating the intricate landscape of wealth transfer.

Understanding Estate Tax

Estate tax is often called the “death tax” or “inheritance tax”. It is a levy imposed on the transfer of an individual’s wealth upon their death. This taxable estate includes the sum of the deceased person’s assets, such as real estate, cash, investments, and other valuables, minus liabilities and allowable deductions. The tax is calculated based on the net value of the estate’s current fair market value. 

Assets inherited by the surviving spouse are generally not subject to the federal estate tax because of the unlimited marital deduction. When the surviving spouse dies, the beneficiaries may owe taxes if the estate exceeds the exclusion limit. 

Purpose of a “Death Tax”

The primary purpose of estate tax is two-fold: to promote a more equitable distribution of wealth and to generate revenue for the federal government and/or state government. By taxing large estates, the government aims to fund public services and initiatives while preventing the concentration of wealth among a small percentage of the population.

Does California Have an Estate Tax?

While some states charge a state estate tax, California does not. While Californians do not need to worry about paying estate taxes at the state level, they may be subject to estate taxes at the federal level if the estate exceeds a certain value.

2024 Federal Tax Rates

For the 2024 tax year, the IRS requires estates with combined gross assets and prior taxable gifts exceeding $13.61 million for one person (or $27.22 million per married couple) to file a federal estate tax return (Form 706) and pay the relevant tax. 

The portion of the estate that’s above this $13.61 million limit in 2024 will be subject to being taxed at the top federal statutory tax rate of 40%. Estates falling below this threshold are typically exempt.

Deductions and Credits

The IRS provides certain deductions and credits to reduce the taxable value of an estate. Common deductions include mortgage debt, funeral expenses, estate administration fees, and charitable contributions. Taking advantage of these allowances can help decrease your overall tax liability.

Tax Reduction Strategies

Proactive estate planning becomes essential given the potential impact of estate tax on one’s wealth transfer. Some options for reducing your estate tax liability may include: 

• Spending: You may wish to reduce your estate size by spending your wealth while you’re still alive.
• Leaving It to Charity: Estate assets left to a 501(c)(3) organization are deductible from your gross estate.
• Gifting: You can reduce your taxable estate by implementing a gifting strategy. In 2024, you can gift up to $18,000 per year to an unlimited number of individuals without incurring gift tax.
• Irrevocable Trusts: By placing assets into an irrevocable trust, you can remove them from your taxable estate. Common types of irrevocable trusts include irrevocable life insurance trusts (or ILITs), intentionally defective grantor trusts (or IDGTs), and A/B trusts (also known as bypass trusts). These are just a few examples of the types of irrevocable trusts that can be used to transfer assets to heirs while minimizing tax liability.

Consult an experienced estate planning attorney and financial advisor to develop a strategy for addressing your personal tax liability.

Understanding these tax basics is key to making informed decisions to preserve and transfer wealth to your loved ones. With proper planning and the right professional guidance, you can ensure a smoother transition of assets and a legacy that aligns with your financial goals.

If you have any questions about this topic, feel free to contact our law firm.

Law Offices of Daniel A. Hunt

The Law Offices of Daniel A. Hunt is a California law firm specializing in Estate Planning; Trust Administration & Litigation; Probate; and Conservatorships. We've helped over 10,000 clients find peace of mind. We serve clients throughout the greater Sacramento region and the state of California.