Tips for Minimizing Estate Taxes on What You Leave Behind

Last will with cash and judge's gavelWhen completing your will and doing your estate planning, many people worry about just how much their estate will be taxed. This is a valid concern, but the good news is that very few estates are subject to a federal estate tax, as the exemption amount is very high. However, your estate could be subject to an estate tax or inheritance tax by your state. Here’s what you need to know about estate and inheritance taxes, and what you can do to minimize how much of your wealth is lost to taxes.

What Is the Federal Estate Tax?

As we’ve already mentioned, the majority of people won’t have their estates taxed by the federal government. This is because the 2021 estate tax exemption is $11.7 million per person, or $23.4 million for a married couple. As you can imagine, very few estates surpass this amount.

If your estate is worth more than this amount, the tax bill can be quite high. The first $1 million of your estate is taxed at a steadily climbing rate between 18% and 39%. But any amount above that first million will be taxed at a stunning 40%. That can be a tough bill to take, especially for your heirs, who might feel like their inheritance is being stolen from them.

What about State Taxes?

Even if your estate is exempt from the federal estate tax, it could still be subject to a state estate tax. Here’s a list of the states that impose their own estate tax, as well as their current exemption rates (all of which are significantly lower than the federal exemption):

  • Connecticut - $7.1 million
  • Hawaii - $5.49 million
  • Illinois - $4 million
  • Maine - $5.87 million
  • Maryland - $5 million
  • Massachusetts - $1 million
  • Minnesota - $3 million
  • New York - $5.93 million
  • Oregon - $1 million
  • Rhode Island - $1,595,156
  • Vermont - $5 million
  • Washington - $2.193 million
  • Washington, D.C. - $4 million

While the thresholds for exemption are much lower for these state taxes, the good news is that the tax rates tend to be much lower as well. While they vary in each state (and vary based on the total value of the state), most do not exceed 20%.

Additionally, six states impose an inheritance tax, which is paid by your heirs after they’ve received their inheritance:

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

Again, tax rates vary by state, and there are often exemptions for many of your heirs. It’s important to do research regarding the exact estate tax and inheritance tax laws for both the state that your estate is located in and the states that your heirs live in.

How Can You Reduce Estate Taxes?

If your estate is valued highly enough to be subject to either the federal estate tax or an estate tax in your state, you’re likely wondering what you can do to reduce the value of your estate, and therefore, reduce the taxes on it. In some cases, you may be able to reduce your estate’s size enough to fall below those aforementioned thresholds. Here are a few common tactics for reducing the size of an estate:

  • Charitable contributions – This well-known tax deduction can also be an effective way to reduce the size of your estate. Many people choose to give to charities throughout their lives, and will even leave a portion of their estate to a charitable cause. If you intend to do the latter, it may be a good idea to increase your contributions to the charity during your lifetime instead, thereby reducing your estate size more quickly and still providing that cause with the financial support you intended to give upon your passing.
  • Planned gifting – This method for reducing an estate’s size has become more popular in recent years, simply because individuals want to witness their loved ones enjoying their inheritance, and seeing how those funds improve their lives. Of course, you don’t have to give someone their entire inheritance at ones—nor should you. You can currently give each person up to $15,000 a year without worrying about taxes. This can allow you to reduce your estate’s value steadily over the years while still passing it on to your intended heirs.
  • Irrevocable life insurance trusts – Sometimes, the value of your life insurance plan can be added to your estate value, which can increase it enough to push you over the estate tax threshold. If you want to avoid this, set up an irrevocable life insurance trust instead; this commits your life insurance payout to a trust, which is transferred to a named beneficiary upon your death, and prevents it from being valued with your estate.

If you have questions about estate taxes—whether on the state or federal level—please contact one of your tax professionals here at Demian & Company CPAs.