Estate taxes are a much-hated feature of the tax laws, with many referring to the provision as a "death tax." But most people never pay estate taxes because of the exemptions that apply to the tax, and the estate tax exemption for 2015 and 2016 can help taxpayers save millions of dollars from the IRS.
How much is the estate tax exemption for 2015 and 2016?
The estate tax exemption gets set each year based on an inflation-adjusted index. For those who die this year, the estate tax exemption for 2015 is $5.43 million. For those dying next year, the exemption for 2016 will be $5.45 million.
What this exemption amount means is that estates with assets worth up to that amount can pass to heirs free of any estate tax. Larger estates are only subject to tax on the excess. For instance, in 2015, a $5 million estate wouldn't incur any estate tax, and a $6 million taxable estate would only owe taxes based on the $570,000 that's above the 2015 exemption amount.
How much can the estate tax exemption save you?
This exemption is especially important when you consider the tax rates that apply to estates. Although the IRS lists rates as low as 18%, they quickly rise to 40% on estates of more than $1 million. When you run the numbers, the maximum savings from the estate tax exemption in 2015 is $2,117,800. The rise in the exemption for 2016 boosts the potential savings next year to $2,125,800.
Married couples should note that each spouse gets an estate tax exemption of his or her own. As a result, couples can transfer twice the exemption amount to their heirs without having to deal with the estate tax. Recent law changes that effectively allow surviving spouses to utilize any unused exemption from a deceased spouse's estate makes it much simpler to get the maximum benefit of nearly $11 million of estate tax protection.
Incorporating lifetime gifts
One thing to keep in mind, though, is that the estate tax exemption is actually a unified provision that also incorporates gift taxes. If you've made any taxable gifts during your lifetime, then those gifts use up a portion of your lifetime exemption amount. The key word here, though, is taxable. Any gifts that make use of other favorable provisions of the tax laws, including the $14,000 annual gift tax exclusion, or the unlimited deduction for gifts to spouses, don't count toward your lifetime exemption.
For example, say one person made a $1 million gift to a spouse and a similar $1 million gift to a child in 2013, and then dies in 2015 with a taxable estate of $5 million. The gift to the spouse doesn't use any lifetime exemption, but the gift to the child uses $986,000 -- the $1 million amount less the $14,000 annual exclusion. Therefore, at death, there's only $4,444,000 of estate tax exemption left, leaving the $556,000 excess subject to tax.
Overall, the estate tax exemption is a useful provision that prevents the vast majority of American taxpayers from having to pay any estate taxes. Wealthier families can save millions from the provision, and it can make tax planning to further reduce remaining estate tax liability much easier.