Leaving a legacy for those who survive you is an important part of a financial preservation strategy. Sometimes a legacy equates to ensuring that your loved ones will have income after you are gone. In some cases, it means giving to a charitable organization. In other cases, beneficiaries of your legacy may owe the federal and some state governments an estate tax.
What Is estate tax?
Estate tax is the tax that heirs pay on the estate left to them. Generally speaking, any individual or organization other than a spouse or a federally-recognized charity will owe federal – and sometimes state – taxes on an estate that exceeds the estate tax limit. In 2020 a filing is required for estates with combined gross assets and prior taxable gifts exceeding $11,580,000.
How is estate tax calculated?
Similar to the concept of gross income on an income tax form, calculating potential federal estate tax requires the knowledge of gross estate, or how much combined assets are worth. Once the gross estate amount is determined, subtract any applicable deductions to find the taxable estate.
Estimating gross estate: hypothetical estate
The gross estate includes the fair market value of everything owed. This includes cash, securities, automobiles, real estate, business interests, and so on. The gross estate also includes the death benefit of any life insurance policies. So, a hypothetical estate might look something like this:
| Cash and savings | $150,000 |
| Securities and annuities | $1,000,000 |
| Retirement Accounts | $1,980,000 |
| Vehicles, RV, Boat | $400,000 |
| Personal assets (furniture, etc.) | $600,000 |
| Residence | $750,000 |
| Other real estate holdings | $1,750,000 |
| Business interests | $6,200,000 |
| Gross estate | $12,300,000 |
Estimating taxable estate: hypothetical estate
Once the estimated your gross estate is determined, subtract applicable deductions to find the taxable estate that will pass to beneficiaries other than a spouse or federally-recognized charities. Based on the hypothetical example gross estate, above, the taxable estate might look something like this:
| Outstanding debts and administrative expenses(approximately 5 percent of gross estate) | -$625,000 |
| Charitable contributions planned at death | -$175,000 |
| Assets that will pass to surviving spouse at death | -Not applicable (no surviving spouse) |
| Taxable estate | $850,000 |
The beneficiaries will owe the taxes owed on a taxable estate. Tax amounts will vary by the year of death. The federal government provides resources for understanding, estimating and filing estate taxes.
Are there exceptions to estate tax?
There are a few exceptions to the estate tax.
- In most cases, if a spouse or a federally-recognized charity will be inheriting assets, estate taxes don’t apply.
- A number of strategies can be used – such as gifting or family partnerships – to help decrease the amount by which the estate will be taxed.
- However, rules vary by year of death and by certain other circumstances, so it’s wise to consult with an attorney or other certified financial professional to learn about which approaches to preserving your legacy for your loved ones apply to your situation.
Note: Provided content is for overview and informational purposes only and is not intended as tax, legal, fiduciary, or investment advice. Neither the companies of OneAmerica nor their representatives provide tax or legal advice. For answers to specific questions and before making any decisions, please consult a qualified attorney or tax advisor.