Who Will Pay Your Estate Taxes?

To a large degree, paying federal estate taxes is voluntary since many estate planning tools are available to eliminate or at least reduce this tax.  Having said that, once your estate reaches over a certain size and you are not married (if you are married you may have an unlimited marital estate deduction for assets transferred to a spouse) – the available estate tax reducing tools may not be adequate to reduce the federal estate tax to zero. Regardless, your lifetime federal estate exclusion for 2020 is $11,580,000. If your taxable estate is less than the lifetime exclusion amount – no federal estate tax is normally due. For most people the current lifetime exclusion of $11,580,000 seems more than enough. But, as recent as 1997, the lifetime exclusion was only $600,000. Who knows how this might change with the possibility of a new incoming administration. The current top federal estate tax rate is 40%. At that rate, if you expect to have a taxable estate, spending some money now for estate planning may reap some huge benefits for your heirs. 

Too often people tend to focus only on their federal estate tax planning and overlook the possibility of a State death or inheritance tax. Currently, about 1/3 of the states have some sort of death or inheritance tax. The State of Ohio ended its death/inheritance tax for any deaths occurring after January 1, 2013.

Side note: Gifts are one of many effective tools for reducing one’s taxable estate.  In 2020, a gift of up to $15,000 may be made to an individual without having to report the gift or reduce your lifetime exclusion.

                                                                                                  -Mark Bradstreet

If you have a taxable estate, consider yourself fortunate. I often tell clients, “paying estate taxes is a good problem to have.” It is better than the alternative – dying with few or no assets. But sometimes little thought is given to who will pay these estate taxes.

An estate tax is a one-time tax that is due nine months from the date of a person’s death. It is not an income tax, although it is easily confused with yearly income taxes that estates, trusts and individuals have to pay. Republicans call it the “death tax.” Democrats and the Internal Revenue Code refer to it as the estate tax. Whatever you call it, it is the same thing – a tax on a person’s assets valued as of the date of death. 

Many estates are exempt from the estate tax. If the value of your assets (and prior taxable gifts) do not reach the filing threshold, an estate tax return may not be due. The federal amount you are allowed to leave in 2020 without paying an estate tax is $11,580, 000. That amount is scheduled to increase for inflation every year until 2026 when it drops to $5,000,000 adjusted for inflation. It also may drop sooner depending on what happens with the November elections. 

Keep in mind that depending on where you live, your state may also have a state estate tax. For example, the exemption amount in Massachusetts is only $1 million. 

If you have a will, it should specify how your estate taxes will be paid. In general, it is your executor’s responsibility to pay your estate taxes. Typically, the will directs your executor to use your probate assets to pay the estate taxes that are due. However, if some of your assets pass outside your will, i.e. by beneficiary designations or joint ownership, there may not be enough assets in your probate estate to pay your estate taxes. This scenario means that the beneficiaries of your will could end up paying a disproportionately greater share of the taxes due. 

To avoid this, you need to pay close attention to the beneficiaries named in your will and the beneficiaries of your non-probate assets such as life insurance policies, IRA’s and 401K’s. If the beneficiaries are not the same, you may stick some people with paying for the estate tax while others receive their assets free and clear of any tax.

Take the example of a woman who died leaving a large “payable on death” account and life insurance policy to her live-in boyfriend. These non-probate assets were paid directly to the boyfriend. They were still included in her taxable estate and taxed for estate tax purposes, but the boyfriend did not have to contribute to the estate taxes. He received the assets free of estate taxes. 

The estate taxes were paid out of the probate estate. The only probate asset was a heavily mortgaged house that was left to nieces and nephews. Because the will stipulated that all estate taxes must be paid from the probate assets, the nieces and nephews were on the hook for the entire estate tax which essentially ate up any monies they were to receive.  

Be sure to discuss payment of estate taxes with your attorney. You do not want to leave some of your beneficiaries to pay the bill while others walk away scot-free.

Credit Given to:  Christine Fletcher published on June 12, 2020 in Forbes.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This week’s Author – Mark Bradstreet, CPA

–until next week.