Estate Tax Laws: An Overview

Planning an estate is an exhaustive process that is surrounded by a large amount of legal and tax implications. Whether you’re planning your estate or in line to receive an inheritance from an estate, it’s important to understand all the legal and tax implications involved and how much you might be looking at paying in taxes. Luckily, most people won’t have to worry about paying estate taxes at the federal level, but some states carry their own rules and estate taxes. While there are plenty of loopholes that enable many people to avoid paying estate taxes, working with an experienced tax attorney can make sure you get the most out of your estate. In this article, we will cover the tax laws involved with estates, inheritance taxes for the states that carry them, and what happens if you don’t pay your estate taxes.

Federal Estate Tax

The federal estate tax is assessed on the current fair market value of the assets included in the estate. This tax is calculated based on what the assets are worth in the present time, not what they were worth in the past or the original value. For the most part, the federal estate tax will probably not apply to you. The IRS exempts estates of less than $12.92 million from the tax in 2023, and it will likely continue to rise. Additionally, this exemption is per person, so married couples have a higher limit. If the estate is above this amount, the IRS taxes them at rates of up to 40%. Here is a short list of the estate tax rates from the IRS:

Gift Tax

According to the IRS, the gift tax is a tax on the transfer of property by one person to another while receiving nothing, or something less than full value, in return. Regardless of whether or not the transfer of property is intended to be a gift, the gift tax still applies. The gift in question can also be any type of property, not just cash or property. This includes things like charitable donations, school tuition or education payments, medical expenses, gifts to spouses, or political contributions. There are two exemptions to the gift tax that pretty much prevent it from playing a big part in Americans' finances: the annual gift tax exclusion and the lifetime exemption.

Annual Gift Exemption

The IRS allows people to donate or give a specific amount of assets each year without having to pay taxes on them. For 2023, this amount was $17,000. This means a person could give up to $17,000 to as many people as they want without paying taxes. For married couples, this is doubled as it is a per person exemption. This means you and your spouse could give a family member $34,000 in 2023 without having to pay any taxes on it. If you go over the exemption, however, there is a similar structure that the IRS will have you pay. It starts at 18% for up to $10,000 over the limit and goes up to 40%.

Lifetime Exemption

There is a way for people to give over the annual exemption amount without having to pay additional taxes on it. An individual would be able to deduct any overage amount from their estate amount, which would come out of their $12.92 million lifetime expansion. For example, if you give your grandson a $45,000 car for their graduation gift, you can deduct the $28,000 overage from your lifetime exemption. 

State Estate Taxes

In addition to the federal estate tax, there are a number of states that have an estate tax, as well as the District of Columbia. Each state has its own exclusion amount, which can be a bit lower than the federal amount of $12.92 million, and each state has its own range of what percentage of the estate is taxed. Here is a breakdown of each state and its exclusion limit for 2023:

State Inheritance Tax

An inheritance tax is a tax on what you receive as the beneficiary of an estate. There are only a few states that have an inheritance tax in lieu of an estate tax. Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania have only an inheritance tax. There are exceptions to the inheritance tax, including spouses and certain heirs. Maryland is the only state that has both an inheritance tax and an estate tax.

Portability for Estate and Gift Tax

Losing a spouse is a tragic event, and it’s important to have a plan in place in case you or your spouse passes away before the other. This is where discussing portability for your estate comes into play. The key advantage of portability is the flexibility that comes along with it. The surviving spouse has to file a federal estate tax return within nine months of the deceased spouse’s death. Portability allows the surviving spouse to deal with their estate planning and the transfer of assets the way their spouse would have wanted to. It means that the surviving spouse can utilize the remainder of their spouse’s estate exemption amount along with their own. If the spouse who passed away had $11 million left in their estate exemption at the time of their passing, their surviving spouse would be able to add that amount to their own estate exemption amount. 

What happens if I don’t pay estate taxes?

Much like not paying your regular taxes, if you owe the IRS money on estate taxes, you will likely be penalized and could potentially face legal action. The IRS will impose penalties and interest on unpaid estate taxes. These penalties can be very significant and will likely increase over time. The exact penalties depend on varying circumstances, but some common penalties are late payment penalties, failure to file penalties, and interest charges on the unpaid amount. Other outcomes for not paying your estate tax can include additional IRS collection actions like placing a lien on the estate, which gives them a legal claim to the estate, legal consequences where the IRS may accuse you of fraud and pursue criminal charges, and impact on the beneficiaries of the estate which could prevent them from seeing anything from the estate.

Do I Need a Tax Attorney if I Didn’t Pay Estate Taxes?

If you didn’t pay your estate taxes, you could face legal trouble from the IRS. It is highly recommended that you work with a seasoned tax lawyer to avoid any negative consequences. Working with a tax attorney on your estate or inheritance tax can have numerous benefits. Some of those benefits include avoiding IRS penalties and interest on the estate or inheritance, avoiding legal consequences from not paying the estate tax, and getting professional help from someone who knows the intricacies of the tax system. An experienced tax attorney will have in-depth knowledge of the complex tax laws that surround estate taxes. They can make sure you meet all the legal requirements and deadlines and stay compliant throughout the entire process.