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If the two things that are inevitable in life are death and taxes, then it's probably no surprise that someone figured out how to impose taxes after the grave. In the U.S., there are actually two different kinds of "death taxes": the estate tax, which is levied by the federal government and certain states, and the inheritance tax, which is levied by only a handful of states.
Read on to learn more about these "death taxes" and see if your assets may be subject to them.
The estate tax
The estate tax is,as the IRS puts it, "a tax on your right to transfer property at your death." All the cash and property you own at the time of death is added up and subjected to some complicated calculations to arrive at the taxable value for the estate. It's unlikely you'll need to worry about the federal estate tax: The IRS offers an exemption on the first $5.49 million of the estate (as of 2017). So unless you think you'll have more than five and a half million dollars to leave after death, you can forget about the federal estate tax.
Most states that levy an estate tax use the federal limit, but there are a few state estate taxes that use a lower amount. For example, both Massachusetts and Oregon have only a $1 million exemption for their estate taxes. That may sound like a lot, but if you have a house, some savings, investments, and a well-funded retirement account -- not to mention jewelry, furniture, and so on -- then your estate could easily be valued at over $1 million.
The inheritance tax
The inheritance tax is only imposed at the state level. Six states have inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. If you're a resident of one of those states when you die, your beneficiaries will likely have to pay an inheritance tax on their bequests. The inheritance tax also applies against any real estate you own that happens to be located in one of these states, even if you're not a resident of the state. The states all have different inheritance tax rates, exemptions, and limits, so check with your state tax agency for details.
If you're concerned about either of these taxes, you can take steps to minimize how much your estate or your beneficiaries will have to pay. One approach is giving the money or property in question to its intended recipient while you're still alive. You'll receive a gift tax exemption of $14,000 per recipient per year, allowing you to dispose of quite a bit of wealth tax-free. If you are married, you can both give out gifts and enjoy a doubled exemption of $28,000 per recipient per year in total. And you can give away yet more money tax-free by paying your intended beneficiaries' medical or tuition fees (you'll need to pay the medical provider or school directly to take advantage of this loophole).
Another way to cut back on estate taxes is to create a trust for your property. This works especially well for your home, since you can keep living in the house even if you've given ownership in it away to the trust. However, for this to work it has to be an irrevocable trust meaning you can't change your mind later and take the house back or give it to someone else. If you decide to go this route, consult a lawyer or tax professional; you'll need to configure your trust with estate taxes in mind.
Choosing your beneficiaries with taxes in mind can have a big impact on how much you (or they) will pay the IRS. Anything left to either your spouse or a qualifying charity doesn't get hit by the federal estate tax.Most states charging inheritance tax also have exemptions for charity beneficiaries. Many charge greatly reduced tax rates to beneficiaries who are close relatives of the deceased (siblings, children, and so on -- check with your state to confirm), and all states exempt spouses from inheritance tax.
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