If you plan to leave assets to your loved ones after your death, then you at least need to consider the possibility that you'll owe federal estate tax. The so-called "death tax" is calculated based on the value of your assets, and the same estate tax rates have applied to taxable estates that have been in place for a long time.
What changes each year is the unified gift and estate tax credit that prevents the vast majority of taxpayers from ever having to pay estate tax. This credit is tied to the tax on an amount known as the lifetime exclusion, which changes every year for inflation. The effective exemption amount will be higher in 2018 than it was in 2017, and that should leave many without having to worry about estate taxes.
Image source: Getty Images.
The 2018 estate tax rates
There are 12 brackets for calculating estate tax:
|
For taxable estates in this range |
You'll Pay This Base Amount of Tax |
Plus This Rate on the Excess Above the Lower End of the Range |
|---|---|---|
|
$0 to $10,000 |
$0 |
18% |
|
$10,000 to $20,000 |
$1,800 |
20% |
|
$20,000 to $40,000 |
$3,800 |
22% |
|
$40,000 to $60,000 |
$8,200 |
24% |
|
$60,000 to $80,000 |
$13,000 |
26% |
|
$80,000 to $100,000 |
$18,200 |
28% |
|
$100,000 to $150,000 |
$23,800 |
30% |
|
$150,000 to $250,000 |
$38,800 |
32% |
|
$250,000 to $500,000 |
$70,800 |
34% |
|
$500,000 to $750,000 |
$155,800 |
37% |
|
$750,000 to $1 million |
$248,300 |
39% |
|
$1 million and up |
$345,800 |
40% |
Data source: IRS.
So taking a simple example, say someone had a $2 million taxable estate. Using the chart above, that would result in tentative tax of $345,800 plus 40% of $1 million, which produces a tentative tax of $745,800. The key question is then whether one can use the unified credit to avoid paying this tax.
Understanding the unified credit and the lifetime exclusion amount
Each year, the lifetime exclusion amount against the estate tax adjusts upward for inflation. For 2018, the exclusion will be $5.6 million. That's $110,000 higher than it was in 2017.
The lifetime exclusion amount determines the appropriate credit. Running the numbers through the tax brackets above, tax on a $5.6 million taxable estate would be $2,185,800. That's the amount of the unified credit. So in the example above, because $745,800 is less than $2,185,800, your estate wouldn't owe any tax at your death.
Because of the way that the credit gets calculated, any estate that does end up paying tax does so at the top 40% rate. So for instance, a $6 million taxable estate would pay 40% on the $400,000 excess above the lifetime exclusion amount, or $160,000 in estate taxes.
What to do to cut your estate tax
For most taxpayers, the $5.6 million lifetime exclusion is more than sufficient to avoid tax. If you're above that limit, then there are other things you can do. In 2018, you can make unlimited annual gifts of up to $15,000 to as many recipients as you would like. These annual exclusion gifts don't count against your lifetime credit, and they potentially reduce your estate tax by $6,000 for every $15,000 that you give. You can make certain types of gifts in even larger amounts without gift or estate tax consequences, including paying medical bills or tuition and fees to colleges and universities on behalf of someone.
One warning, though, is that some states have their own state estate taxes, and not all of them share the $5.6 million exemption limit. In some jurisdictions, estate taxes take effect for estates of $1 million or less. Not all states follow other rules in the federal estate tax system, so it's also important to contact your state's tax department and make sure you're aware of any discrepancies between state and federal estate tax law.
Finally, the federal estate tax could disappear if tax reform takes place. The proposed package of tax law changes includes getting rid of the estate tax entirely. Some believe that's a bargaining chip that could return to the table, but few people support the tax and so it could end up being included in final versions of legislation.
Know what you'll owe
The large exclusion means only a small fraction of taxpayers will have to worry about paying estate taxes. By knowing the 2018 estate tax rates and applicable exclusion amounts, you can plan for whatever scenario is most likely for you in your financial situation.
