Estate Tax Exemption

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on May 26, 2023

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What Are Estate Tax Exemptions?

Estate tax exemptions refer to the amount of an estate's value that is not subject to federal or state estate taxes. The exemption amount is determined by the government and can be adjusted based on various economic and political factors.

Currently, the federal estate tax exemption is $12.92 million per individual, while some states have their own estate tax with varying exemption amounts. Proper estate planning can help individuals maximize their exemption and minimize their tax liability.

Estate Tax Exemption Thresholds

Federal Estate Tax Exemption

Historical Exemption Amounts

Over the years, the federal estate tax exemption amount has changed due to legislative adjustments and economic factors. These changes have generally increased the exemption amount, reducing the number of estates subject to taxation.

Current Exemption Amount

As of 2023, the federal estate tax exemption stands at $12.92 million per individual. This means that estates valued at or below this amount are not subject to federal estate tax, while those exceeding this threshold are taxed at a rate that ranges from 18% to 40%.

Inflation Adjustments

The federal estate tax exemption is adjusted annually for inflation, ensuring that the exemption amount remains relevant as economic conditions change. This allows for a more equitable application of the estate tax and prevents undue hardship on taxpayers.

State Estate Tax Exemption

Variations by State

In addition to the federal estate tax exemption, several states also impose their own estate tax with varying exemption amounts. Some states conform to the federal exemption amount, while others set their own, often lower, exemption thresholds.

Exemption Amounts

State estate tax exemption amounts can differ significantly from the federal exemption, which is why it is essential for individuals to be aware of the specific exemption thresholds in their state of residence.

Portability of Exemption

In some cases, state estate tax exemptions are portable, meaning that a surviving spouse can utilize any unused portion of their deceased spouse's exemption. This can be particularly beneficial in reducing or eliminating state estate tax liabilities.

Portability of Estate Tax Exemption

Definition of Portability

Portability is a feature of the federal estate tax exemption that allows a surviving spouse to claim any unused portion of their deceased spouse's exemption amount, effectively increasing their own exemption.

Process for Claiming Portability

To claim portability, the executor of the deceased spouse's estate must file an estate tax return (Form 706) within nine months of the date of death, even if no estate tax is due. This filing enables the surviving spouse to utilize the unused exemption in the future.

Benefits of Portability

Portability can provide significant tax savings for married couples, particularly those with substantial assets. By combining both spouses' exemptions, a couple can shield a larger portion of their estate from taxation.

Limitations of Portability

While portability offers numerous benefits, it is essential to note that it only applies to the federal estate tax exemption and may not be available for state estate tax exemptions. Additionally, portability does not extend to other estate planning techniques, such as the use of trusts.

Strategies for Maximizing Estate Tax Exemption

Gifting During Lifetime

Annual Gift Tax Exclusion

One strategy for maximizing the estate tax exemption is to make gifts during one's lifetime. The annual gift tax exclusion allows individuals to gift up to $15,000 per recipient per year (as of 2021) without incurring gift tax or reducing their lifetime gift tax exemption.

Lifetime Gift Tax Exemption

In addition to the annual exclusion, individuals can also make use of the lifetime gift tax exemption.

This exemption, which is equal to the federal estate tax exemption, allows individuals to make cumulative gifts above the annual exclusion amount without incurring gift tax or affecting their estate tax exemption.

Utilizing Trusts

Revocable Living Trusts

Revocable living trusts can be an effective estate planning tool for maximizing estate tax exemption. These trusts allow individuals to transfer assets into the trust during their lifetime, avoiding probate and providing more control over asset distribution.

However, assets in a revocable living trust are still considered part of the grantor's taxable estate for estate tax purposes.

Irrevocable Trusts

Irrevocable trusts can provide even more significant tax benefits, as assets placed in these trusts are removed from the grantor's taxable estate. This can reduce or eliminate estate tax liability while still providing for the grantor's beneficiaries.

However, irrevocable trusts cannot be altered or revoked once established, so it's crucial to carefully consider the implications before implementing this strategy.

Charitable Trusts

Charitable trusts are another option for maximizing estate tax exemption while also supporting a philanthropic cause. These trusts can be structured to provide income to beneficiaries for a specified period, with the remaining assets ultimately passing to a designated charity.

This strategy can reduce estate tax liability and provide significant income tax deductions for the grantor.

Estate Planning Techniques

Family Limited Partnerships

Family limited partnerships (FLPs) can be used to transfer assets to family members while retaining control over the assets and reducing estate tax liability.

FLPs can provide valuation discounts, as the transferred interests may be valued lower due to limited marketability and lack of control, effectively reducing the overall estate value.

Grantor Retained Annuity Trusts

Grantor retained annuity trusts (GRATs) involve transferring assets into a trust while retaining the right to receive annuity payments for a specified term. At the end of the term, any remaining assets in the trust pass to the beneficiaries.

GRATs can be an effective way to transfer asset appreciation to beneficiaries with minimal or no estate tax consequences.

Qualified Personal Residence Trusts

Qualified personal residence trusts (QPRTs) involve transferring a personal residence into a trust, with the grantor retaining the right to live in the property for a specified term. After the term, the residence passes to the beneficiaries at a reduced estate tax value.

This strategy can be particularly beneficial for individuals with valuable real estate holdings.

Strategies for Maximizing Estate Tax Exemption

Estate Tax Exemption in Special Circumstances

Exemption for Family Farms and Businesses

Certain family farms and businesses may qualify for an additional estate tax exemption, allowing these valuable assets to pass to the next generation with reduced or no estate tax burden.

This exemption is intended to preserve family-owned enterprises and protect them from potential financial strain due to estate taxes.

Exemption for Non-resident Aliens

Non-resident aliens are subject to U.S. estate tax on their U.S.-situated assets, but they are granted a reduced estate tax exemption of $60,000.

Tax treaties with specific countries may provide for a more generous exemption or other benefits, so it's important for non-resident aliens to understand their potential estate tax liability.

Exemption for Spouses

Transfers of assets between U.S. citizen spouses, either during life or at death, are generally not subject to estate tax due to the unlimited marital deduction.

However, transfers to non-citizen spouses may be subject to estate tax, although a generous annual exclusion amount exists for lifetime gifts to non-citizen spouses.

Impact of Estate Tax Exemption on Beneficiaries

Tax Implications

The estate tax exemption can significantly impact beneficiaries by reducing or eliminating the estate tax burden, allowing them to inherit assets without the added financial strain of tax liabilities.

Asset Distribution

Maximizing the estate tax exemption may also affect asset distribution among beneficiaries, as individuals may employ various strategies to ensure assets are distributed in a tax-efficient manner.

This can include the use of trusts, gifting strategies, and other estate planning techniques to allocate assets among beneficiaries while minimizing estate tax exposure.

Basis Step-up

One critical aspect of estate tax exemption that affects beneficiaries is the step-up in basis. When assets are inherited, their tax basis is "stepped-up" to the fair market value as of the date of the decedent's death.

This can minimize or eliminate capital gains tax liability for beneficiaries when they eventually sell the inherited assets, further enhancing the tax benefits of estate tax exemption.

Conclusion

Importance of Estate Tax Planning

Estate tax planning is essential for individuals with substantial assets, as it can help maximize the estate tax exemption and minimize the tax burden on beneficiaries.

By understanding the various exemption thresholds, portability, and strategies for maximizing the exemption, individuals can create an effective estate plan that meets their needs and protects their assets for future generations.

Periodic Review of Estate Plan

It is important to review and update estate plans periodically to ensure they remain aligned with one's goals and circumstances. Changes in tax laws, family situations, and financial conditions may necessitate adjustments to the estate plan to optimize tax benefits and protect assets.

Consulting with Estate Planning Professionals

Given the complexity of estate tax exemption and the various strategies available for maximizing its benefits, it is highly recommended to consult with experienced estate planning professionals, such as attorneys, accountants, and financial advisors.

These professionals can provide guidance on the most suitable strategies for one's unique situation and help navigate the often-complex world of estate tax planning.

Estate Tax Exemption FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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