Sales Strategy

Everything you need to know about estate and gift taxes

Estimated 4m read
Sales Strategy

Everything you need to know about estate and gift taxes

Sales Strategy

Everything you need to know about estate and gift taxes

Estimated 4m read
Sales Strategy

Everything you need to know about estate and gift taxes

Estimated 4m read
Sales Strategy

Everything you need to know about estate and gift taxes

Estimated 4m read
Sales Strategy

Everything you need to know about estate and gift taxes

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By Modern Life
October 5, 2023
By Modern Life
Oct 5, 2023
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Navigating the intricacies of estate planning can be daunting, especially when it comes to understanding the implications of estate taxes.  In this article, we’ll provide insights on federal and state estate taxes and inheritance taxes. 

Federal estate taxes

Preparation for federal estate taxes is an essential aspect of estate planning that individuals and families should be aware of. Here are some key things individuals should know about federal estate taxes.

Thresholds and exemptions

In 2023, the federal estate tax applies to estates with a total value exceeding $12.9 million for an individual and $25.8 million for a married couple, which do increase each year with an inflation adjustment. Estates valued below these thresholds are generally not subject to federal estate taxes. Any amount over the exemption threshold is subject to a graduated tax rate between 18% to 40%. However, staying updated on these thresholds is crucial, as they can change over time with legislative updates.

Estate tax sunset

The tax provisions within the Tax Cuts and Jobs Act (TCJA) of 2017 are set to expire at the end of 2025, which individuals should be prepared for. The TCJA had temporarily increased the federal estate tax exemptions but is set to revert to their pre-TCJA levels in January 2026, adjusted for inflation. Without congressional action, the current lifetime estate and gift tax exemption of the abovementioned amounts will be cut in half.

Gift Tax

The federal government also taxes large financial gifts made during one's lifetime, such as money, property, or investments. The annual gift tax exclusion is $17,000 in 2023, meaning an individual can gift up to that amount to anyone this year without incurring any gift tax. Similarly, the lifetime gift exemption is coupled with the estate tax exemption amounts - $12.9 million per individual and $25.8 million per couple, with gift splitting. Any gifts over these amounts are subject to gift taxes. Also important to note is the three-year look-back rule.  This applies to any gifts made within three years before the individual's death and would bring the gift back into the taxable estate. 

When does an estate tax have to be paid?

In general, the estate's executor must file IRS Form 706 within nine months of the date of death. For example, if the decedent passed away on January 1, the estate tax return would typically be due by October 1 of the same year. If needed, a six-month extension can be applied for through form 4768.

Exemptions and deductions

Keep in mind only assets held within the estate are subject to taxes. Those held outside the estate, like those in an Irrevocable Life Insurance Trust (ILIT), are not. For example, when an individual owns a life insurance policy personally, the death benefit is typically included in their estate for tax purposes. By transferring ownership of the policy to an ILIT (or having the ILIT own the policy from day one) and naming the ILIT as the beneficiary, the individual effectively removes the policy's value from their estate. As a result, when they pass away, the insurance proceeds are not subject to estate taxes, thus preserving more wealth for the intended recipients.

Deductions can also reduce the amount of an individual’s (or couple’s) taxable estate, potentially lowering the overall estate tax liability. Some common examples include:

  • Charitable giving: If an individual leaves assets to qualifying charitable organizations through their estate, the value of those philanthropic gifts can be deducted from the taxable estate. 
  • Debts and administration expenses: Outstanding debts, such as a mortgage, can be deducted from the estate. In addition, final expenses like funeral and administrative costs can also reduce the taxable estate. 

Life insurance and estate taxes

Life insurance, specifically the death benefit, can be valuable for addressing estate taxes. If the estate primarily consists of illiquid assets like real estate or closely held businesses, raising the necessary funds to pay the estate tax bill can be challenging. Life insurance can provide immediate cash from the death benefit, ensuring the estate has the liquidity to satisfy its tax obligations without selling assets.

State estate taxes

In addition to federal estate taxes, 12 states plus the District of Columbia have their own estate taxes:

  • Maine 
  • Vermont
  • Massachusetts
  • New York
  • Connecticut
  • Rhode Island
  • Maryland
  • Illinois
  • Minnesota
  • Washington
  • Oregon
  • Hawaii 
  • D.C.

Each state has its own threshold and tax rate. For example, in Massachusetts, any estate valued over $1 million is subject to a tax between 0.8% and 16%. 

Inheritance taxes

Unlike estate taxes, where the estate is responsible for paying the tax, an inheritance tax falls solely on the shoulders of the beneficiary of those assets. Currently, six states have an inheritance tax:

  • New Jersey
  • Pennsylvania
  • Iowa
  • Kentucky
  • Nebraska 
  • Maryland*

*Maryland is the only state with both an estate and inheritance tax.

Next steps

Individuals can prepare for taxes in their estate plans in several ways. First, they can utilize the annual gift tax exclusion to give tax-free gifts to beneficiaries within the limit each year or take advantage of their lifetime gift exemption. Second, they can establish an ILIT to transfer assets outside their taxable estate. Third, they should create a comprehensive inventory of their assets and debts to facilitate a smooth estate administration process. Consulting with an experienced estate planning attorney and staying informed about changes in tax laws is crucial to ensuring their estate plan aligns with current regulations, ultimately minimizing the impact of estate taxes on their heirs.

A Brokerage like Modern Life can provide valuable assistance with estate planning by offering access to a wide range of life insurance products and expertise in tailoring insurance solutions to meet the specific needs of individuals in their estate planning. 

We help financial advisors and their clients compare policies, navigate underwriting processes, and obtain competitive quotes, ensuring that the life insurance component of their estate plan is cost-effective and tailored to their unique circumstances. This support simplifies the often complex task of incorporating life insurance into estate planning, offering clients and their beneficiaries peace of mind.

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