How Are Estates Taxed?
Navigating the world of taxes can be complex, especially when it comes to estate taxes that affect high-net-worth families. This blog article will shed light on how estates are taxed and provide insightful guidance to help you plan accordingly. Whether you’re an executor of an estate, a beneficiary, or simply planning for your family’s future, it’s critical to understand the intricacies of estate taxation.
Federal Estate Tax Thresholds and Rates
Estates with a “net” value exceeding $13,610,000 in the year 2024 are subject to a Federal estate tax at a rate of 40%. The value of the estate can be calculated based not only on the date of the decedent’s death but also on an “alternate valuation date” which is six months following their death. Choosing the alternate valuation date is mandatory for all assets and is particularly useful if the asset values decline post mortem. Typically, without an extension, the estate tax payment is due nine months after the decedent’s death.
Deferral Options for Federal Estate Taxes
Federal estate taxes can be deferred under several circumstances:
1) For Reasonable Cause (up to 12 months):
Executors may have the tax deferred if they demonstrate “reasonable cause,” such as an inability to access estate assets within the 9-month window due to litigation, or when assets consist of royalties or other income received over time.
2) For Undue Hardship (year-by-year up to 10 years):
An “undue hardship” deferral is possible if selling assets within the 9-month period would result in a fire sale situation — where no market is present or selling during that timeframe would severely undervalue the assets.
3) Active Trade or Business Assets (up to 14 years):
Under Internal Revenue Code Section 6166, deferral is allowed for active trade or business assets, provided they make up more than 35% of the estate. The deferral is over 14 years, with interest payable for the first four years, followed by installments of interest plus principal.
Estate and Inheritance Taxes at the State Level
In addition to Federal estate taxes, certain states also levy their own estate and/or inheritance taxes as of 2024. These states include Connecticut, DC, Hawaii, Illinois, Iowa, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Nebraska, NY, NJ, Oregon, Pennsylvania, Rhode Island, Vermont, and Washington, each with its own exemptions and top tax rates between 15% and 20%.
Understanding the Basis in Estate Tax Planning
Income tax basis is a vital concept in estate tax planning. Basis is essentially the asset’s cost basis and determines the capital gains tax on the asset’s sale. Assets held until death receive a “stepped-up” basis, equating to their date of death value. In contrast, assets gifted during life retain a “carryover” basis (the donor’s basis).
Distribution of Tax Responsibilities
Typically, each individual is responsible for their share of the tax. However, estate planning documents like wills can modify this, often stipulating that specific bequests are free of tax, which is instead borne by the residue of the estate.
Penalties
Failure to pay estate taxes when due can result in penalties, for which the executor may become personally liable.
Conclusion
Understanding estate taxes is crucial for high-net-worth families to ensure proper wealth management and seamless transitions. With substantial assets at stake, being well-informed and prepared can save families from unnecessary financial strain. It’s advisable to work with estate planning professionals who can provide personalized strategies ensuring compliance with state and Federal tax laws. Remember, informed planning is the best defense against the complexities of estate taxation.