You’ve probably heard the term “death tax,” but what does it mean? Dead men tell no tales—nor do they pay taxes. When you pass away, who has to pay tax on what you leave behind? That depends on several factors, including how much you leave, the people and/or organizations you leave it to, and how you go about transferring it. To get a basic understanding of how this all works, we’ll look at three kinds of taxes: estate tax, gift tax, and inheritance tax.
The estate tax is levied against an estate before it is distributed to beneficiaries. It applies only to people who leave behind sizable estates, and this has become increasingly true in recent years. In 2001, an estate tax return was required for estates totaling $675,000 in gross assets. Since then, the amount that is exempt from estate taxes has skyrocketed to its current level of $11.4 million. Even if you have an estate that is worth more than this, keep in mind that only the amount above the exemption level is subject to this tax. For example, for an estate worth $12 million, just $600,000 would be subject to estate tax in 2019.
Another important thing to note about the estate tax is that it does not apply to wealth transferred to a surviving spouse. No matter the size of your estate, estate taxes will not be due if you leave it all to your spouse. If your spouse later dies leaving more than the exempted amount to non-spouse beneficiaries, however, the amount over the exemption limit will then be subject to estate tax.
One way to avoid the estate tax is to reduce the amount of your estate during your lifetime through giving. In 2019, the IRS allows taxpayers to give away up to $15,000 per recipient without incurring any tax obligation; married couples, even if they file jointly, can give away $15,000 each for a total of $30,000 per recipient. If you give away property other than cash, get an appraisal of the property’s fair market value, and be sure to retain all records related to your gifts for tax filing time. Note that because the limit applies to each recipient rather than to the donor, there is no limit to the amount of wealth you can transfer tax free through gifts.
There are some gifts that are not subject to the gift tax, even if they exceed the exemption limit. Gifts in the form of medical expenses or school tuition paid directly to the providing medical or educational institutions are exempt from this tax, as are gifts to political organizations. Donations to charities are considered separately from gifts and are tax deductible if itemized on Form 1040’s Schedule A. Charitable donations can total up to 50% of adjusted gross income per year, providing certain criteria are met. If you are interested in making substantial gifts and/or donations, a tax planning professional can help you structure these gifts to do the most good for those you wish to benefit.
While estate tax is paid by the estate before distribution to heirs, an inheritance tax is paid by beneficiaries after the inheritance is received. There is no federal inheritance tax, but some states, including Iowa, have their own inheritance tax laws. As with estate taxes, wealth passed to surviving spouses is exempt. Since 1997, Iowa has broadened its list of exempt heirs to include
- Parents and their lineal ascendants
- Children, stepchildren, and their lineal descendants
Estates worth $25,000 or more are subject to Iowa’s inheritance tax. Before the value of the estate is determined, however, costs such as unpaid debts, funeral expenses, attorney and trustee fees, and certain unpaid taxes are deducted. If the estate is worth at least $25,000 after these costs are taken out, then bequests to others are subject to various levels of tax. For example,
- 5–10% for siblings, half siblings, and children-in-law
- 10–15% for foster children, aunts/uncles, nieces/nephews, cousins, siblings-in-law, and step grandchildren
With proper planning, the answer to, “Who pays the taxes when I’m dead?” could be “no one.” Boelman Shaw Tax and Financial Planning combines expertise in these two interrelated fields to provide our clients the best possible financial guidance. By specializing in both tax and financial planning, we gain a wider view of our clients’ financial picture and, as a result, are better able to help them make the most of their money. Give us a call to talk about planning your estate, or subscribe to our blog to get regular updates on important financial topics.
Material discussed herewith is meant for general illustration and/or informational purposes only, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice.