As the baby boom generation members age, they will eventually pass on their wealth to the next generation. When this occurs, millennials must be prepared to pay taxes on their inheritances, says a recent article, “Millennials May Inherit $68 Trillion: Here’s What to Know About Estate and Inheritance Taxes,” from The Motley Fool.
Estate taxes are imposed on the transfer of assets after someone dies. Not every estate in the U.S. is subject to federal estate tax. Only estates valued above a certain threshold are subject to taxes. This is currently $12.92 million for singles and $25.84 for married couples. No federal estate tax is due if the estate is below this amount.
Estate taxes are paid by the decedent’s estate, not the person who inherits the wealth. When a person dies, their executor is responsible for completing the estate tax return and paying any taxes owed. The estate of the decedent person will only pay taxes on the amount over this threshold.
Estate taxes are levied on all assets a person owns at their death, including real estate, stocks, bonds, jewelry, cash and other valuables. The percentage of estate tax charged ranges from 18% to 40% of the estate’s total value. For example, an estate is valued at $15.5 million in 2023, and the expenses incurred before death—medical, funeral costs, etc., cost $500,000. You’d subtract this amount from the estate’s total value ($15.5 million—$500,000—$12.92 million threshold). Since the taxable amount is over $1 million, it will be subject to a 40% tax rate—making the taxes owed $832,000. The after-tax for heirs would be $14,168,000.
In addition, some states levy their own estate taxes. Twelve states have an estate tax: Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington and the District of Columbia. Five states have only an inheritance tax—Iowa, Kentucky, Nebraska, New Jersey, Pennsylvania, and Maryland have a state estate tax plus an inheritance tax.
Can you protect your heirs from estate taxes? In a word, yes!
There are many ways to avoid federal and state estate taxes. One is to gift money and assets to loved ones while living, taking advantage of the annual gift tax exclusion, which lets you give up to $17,000 per person without incurring any taxes.
Another is to place assets in a trust. Your estate planning attorney will advise you on what kind of trust works best for your situation. For example, charitable trusts donate portions of your estate to a charity while taking the assets out of your taxable estate.
Once the Tax Cuts and Jobs Act of 2017 expires, the federal estate tax exemption will return to the $5.49 million exemption, around $6.2 million when adjusted for inflation. Therefore, it is essential for anyone whose estate may exceed this considerably lower threshold to plan now to avoid having to pay estate taxes after December 31, 2025.
Reference: The Motley Fool (May 2, 2023) “Millennials May Inherit $68 Trillion: Here’s What to Know About Estate and Inheritance Taxes”