Estates and Inheritance—Tax Liabilities

Laws Governing Taxation on the Transfer of Property After Death

In the United States, a common form of revenue collection by governmental entities is a transfer tax, assessed when ownership or title to property is legally conveyed from one person or entity to another. One of the most common forms of a transfer tax is an estate tax, levied when the property of a deceased person transfers to another person through their estate.

The first estate taxes in the United States were put in place in 1797, when Congress enacted a law requiring that federal stamps be affixed to all wills offered for probate. The revenue from the sale of those stamps went into federal coffers to amass a fleet of ships for an as-yet-undeclared war against France. The war never materialized, and the tax was repealed in 1802. Over the next century, Congress implemented a federal estate tax twice—to fund the buildup to the American Civil War and to fund involvement in the Spanish-American War.

Congress implemented a federal estate tax again in the Revenue Act of 1916, and it has remained in place ever since, changing primarily in the rates assessed.

What Is an Estate Tax?

While an estate tax is technically a transfer tax, it is actually assessed on the net value of a person’s estate after death but before distribution to heirs and beneficiaries. The objective of the estate tax is to minimize the tax breaks given to extremely wealthy families as their net worth grows. Without the estate tax, that growing wealth might otherwise go untaxed as it transfers from generation to generation.

Inheritance Tax vs. Estate Tax

An inheritance tax is a levy by the government on the value of inherited property, assessed to the heir after receipt. An inheritance tax is calculated based on the fair market value of the property received by the heir. In contrast, an estate tax is paid by the estate prior to any distributions to heirs, and the amount of an estate tax is assessed based on the total value of the decedent’s estate. There is no federal inheritance tax, but six states have laws imposing inheritance tax.

What Are the Sources of Estate and Inheritance Tax Law?

Most estate taxes are imposed at the federal level, governed by the provisions of the Internal Revenue Code and found in Title 26 of the U.S. Code, Subtitle B. There is no federal inheritance tax.

Twelve states impose their own estate taxes by state statute, and six states impose an inheritance tax. (One state—Maryland—imposes both.)

Federal Estate Tax Rates and Exemptions

As of 2022, most estates pay no federal estate tax. Estates smaller than $12.06 million are exempt from federal estate tax. (That exemption is per person, so it’s possible for a married couple to double it.) The IRS taxes estates above the exempt amount at rate brackets ranging from 18% to 40% of the value of the estate assets before distribution. It’s also worth noting that assets inherited by a surviving spouse are not subject to the federal estate tax because of the unlimited marital deduction.

In states that have a state-level estate tax, it’s possible for an estate to fully qualify for the federal estate tax exemption and still remain responsible for a state-level tax.

What Deductions Are Available for Estate Tax Purposes?

There are generally four deductions that may be used to lower a potential estate tax:

• Any expenses associated with administration of the estate in probate
• Any losses incurred during the administration of the estate in probate
• Any mortgages or debt held by the deceased at the time of death
• The value of any property left to a qualifying charity

Filing a Federal Estate Tax Return

If the total value of all assets in the estate is less than $12.06 million (the amount of the unified credit as of 2022), then no estate tax is due and no federal estate tax return needs to be filed. (If the estate is subject to state estate tax, a state return may still need to be filed.) The federal estate tax return must be filed within nine months of the date of death unless you are approved for an extension.

If assets held by the estate generate income greater than $600, then the estate must also file an estate income tax return, which is separate from the estate tax return.

In addition to the returns for the estate, the executor or administrator of a person’s estate should also file the individual’s final income tax return for income earned during the year of their death. The return covers income earned from January 1 through the date of death and is due on April 15 of the following year.

Strategies for Minimizing or Avoiding Estate Taxes

The federal estate tax is levied on any assets held by the estate for distribution to heirs or beneficiaries. There are some exemptions that can be claimed for federal estate taxes, including the $12.06 million federal unified credit. A person may also avoid estate tax liability by keeping assets out of the estate. Ways to do that include:

• Making lifetime gifts of property to friends or family—As of 2022, the limit on tax-free gifts is $16,000 per year ($32,000 for married couples). There’s no limit on the annual number of gifts that may be made.
• Put property into an irrevocable trust—When you put property into such a trust, you no longer own it, and it won’t pass through your estate. Because it won’t pass into your estate, it won’t be subject to estate taxation.
• Make gifts to charitable organizations—You can do this during your lifetime or in your will. It can also be done by setting up a charitable trust.
• Set up a family limited partnership—You can create a family business and transfer assets to the business. Because the business owns those assets, they will not be part of your estate and won’t be subject to estate taxation.

Summary

In the United States, assets that pass through a person’s estate may be subject to a federal estate tax. The current unified credit allows for a $12.06 million exemption from estate tax for each person (potentially $24.12 million for a married couple). An estate above that amount is taxed at a rate ranging from 18% to 40% of the value of the assets. Limited deductions apply that can lower estate tax liability, but a person may avoid estate tax liability by transferring property to others so that the property is no longer part of the taxable estate. Inheritance taxes, unlike estate taxes, are assessed on the value of property received by an heir.