One of the most highly debated tax topics in recent years has been the estate tax, and that debate is only going to get more intense as President Donald Trump has made it clear he hopes to eliminate the federal version of what is widely known as the "death tax."
Republicans have long argued that estate taxes are unfair because they tax money which has already been taxed. That's a strong argument against the tax, which has survived previous efforts to eliminate it, but even if the federal version goes away, some Americans will still have to face an estate or inheritance tax.
Currently, 14 states and the District of Columbia have an estate tax, while six states have an inheritance tax, and Maryland and New Jersey have both, according to Tax Foundation. The nonprofit tax policy institute also points out that rates vary widely across the states, as do the amounts that can be exempted. In addition, rules vary as to who is exempt from the death tax, with some states only exempting spouses while others include children.
What is the federal estate tax?
Before you examine whether your state assesses an estate or inheritance tax, it's important to understand where the federal versions stand now. Under the current rules, estates are taxable when their total value exceeds $5.49 million. To calculate that value, according to the Internal Revenue Service (IRS), you have to use fair market value for any non-cash or cash equivalent assets, not what you paid for them. In addition, any taxable gifts made after 1976, must be computed and subtracted from the available credit.
If your estate exceeds the threshold, whoever inherits it pays a 40% tax on the dollar value over the $5.49 million limit. In most cases all federal estate taxes must be paid within nine months after the death occurs, which can be challenging when the estate consists mostly of non-cash assets like business or property.
There are state taxes, too
While the federal tax, onerous as it may be for some, is pretty straightforward, there is wide variance among the 14 states, plus Washington, D.C., that have estate or inheritance taxes. It's also worth noting that an estate tax is not the same thing as an inheritance tax, though the difference is subtle.
Estate taxes must be paid by the estate before it can be distributed to beneficiaries. Inheritance taxes are paid by the persons who inherit the money.
"The state with the highest maximum estate tax rate is Washington (20 percent), followed by ten states and the District of Columbia with a top rate of 16 percent. Delaware and Hawaii have the highest exemption thresholds, which at $5,450,000 match the federal exemption. At $675,000, New Jersey's exemption is the lowest," explains the Tax Foundation. "Of the six states with inheritance taxes, Kentucky and New Jersey have the highest top rates at 16%. Maryland offers the lowest top rate, at 10 percent."
The states with estate taxes as of 2016 were Connecticut, Delaware, Hawaii, Illinois, Maine, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia. New Jersey and Maryland have both an estate and an inheritance tax, while Iowa, Kentucky, Nebraska, and Pennsylvania have only inheritance taxes.
How can you avoid estate taxes?
Since not dying remains an elusive option for most people, the best way to avoid estate taxes, whether it be the federal one or a state one, is to work with an estate planner to minimize your exposure. A charitable trust, for example, can be used to keep an estate below the threshold, or at least allow the person whose money it was in the first place to have more say over how the assets are disposed of after his or her death.
It's also worth noting that the federal law may change or be eliminated, and states regularly make changes to their laws. To be prepared for that, and to avoid leaving your heirs a potentially nasty surprise, it's important to work with a professional to make sure you have taken the correct steps to guarantee that what you want to happen after you die is what actually does happen.