“WHAT IS THE DEATH TAX AND HOW DO I AVOID IT?”

The “death tax” is an informal name for the federal estate tax. The term is also sometimes used to describe inheritance or estate taxes levied by a state. 

Most of us probably don’t need to worry about the death tax. That’s because federal tax law allows estates to exclude a certain amount in a tax year up to a certain threshold. Estates of people who die during 2020 have an exclusion amount of $11.58 million, up from a total of $11.4 million for people who died in 2019. This means:

  • An individual may leave $11.58 million to heirs with NO federal or gift taxes due.
  • A married couple will be able to leave $23.16 million.

Moreover, if the heir is a spouse, the estate they’re inheriting may not be subject to the estate tax at all. The 100% marital deduction generally allows surviving spouses to inherit without paying estate tax, no matter the size of the estate.

Are these numbers permanent?  Well, no (and herein lies frustrating news for some).  The federal tax reform law that passed in December 2017 doubled the estate tax exemption amount from $5 million to $10 million. But the increase made by the Tax Cuts and Jobs Act is temporary, applying only to tax years between Dec. 31, 2017, and Jan. 1, 2026. That means the threshold amount is set to change at the end of 2025, unless Congress acts to extend the increase or change it in some other way.

What about tax implications for the people who receive your estate?  Beneficiaries usually do not have to report inheritance on their state or federal income tax return because an inheritance is not considered taxable income. But the type of property you inherit might come with some built-in income tax consequences.  Examples:

  • If you inherit a traditional IRA or a 401(k), you’ll have to include all distributions you take out of the account in your ordinary federal income, and possibly your state income as well.
  • If you inherit a rental property that later generates rental income or stocks that pay dividends, you may face a tax bill for that income.

As you can see, there are many misconceptions about taxes and inheritances. Consulting with an elder law attorney to understand these issues, as well as how to avoid the costs of probate and long term care, may put your mind at ease.