The estate tax is applied on all property (including houses, heirlooms, jewelry, etc.) that is to be transferred to heirs or beneficiaries upon the subject’s death. It is a tax that is paid on assets or estates that are valued over a certain limit, and these limits vary at the state and federal level. The tax is calculated based on the fair market value of the estate.
Some form of tax on inheritance has been in effect since 1797. However, the modern version of the Estate tax was first formulated in 1916 and was only instituted to pay for the extra expenses incurred during the World War I.
By 2001, all fifty states had to pay an estate tax. However, this didn’t last long, following a furious debate. After a lot of compromise, a revised version of the estate tax was imposed in 2011, despite being eliminated in 2010.
Today, 12 states in the Union and the District of Columbia have the estate tax. A further four have the tax imposed for deaths that have occurred before January 2013. The estate tax laws differ from state to state. The taxes however, are always paid at the federal level.
As you can imagine, the estate tax in 2019 is a very complicated thing. Here’s what you’ll need to know about paying it.
The Differences within the Estate tax
There are two major kinds of estate taxes that are evident at the federal and state level. The federal estate tax is applicable to every single property in the United States. It applies to all property that is to be transferred at the time of death. However, this doesn’t mean that it is an inheritance tax.
Differences Between Estate and Inheritance Tax
This is a common mistake that people make regarding Estate and Inheritance Tax. Upon someone’s death, if property and other assets are to be transferred to another party, both taxes will be applicable. However, the estate tax is placed on the estate itself. They aren’t paid by the beneficiaries or any other third party.
However, inheritance taxes fall on the beneficiary of the estate. This means that everyone getting a piece of the pie will be responsible for paying the tax on it.
The Federal and the State Estate tax
In 2019, 12 States and the District of Columbia paid the state-mandated estate tax. For all the states, the exemption limit is different as it is at the federal level.
Federal Estate tax
At the federal level, if your property is valued over $11.4 million, then you have to pay an estate tax. This tax will be applied on all value over the $11.4 million limit. Hence, if your estate is worth $20 million, the tax would be applied to the $9.6 million over the limit. This could be as much as 40% and can vary depending on various factors. If your estate is worth less than the limit, then you will be subject to estate tax exemption.
For instance, for married couples, the value of the limit is doubled ($22.8 million). Each year, this limit is adjusted for inflation. There is also a general exception for the federal estate tax if the property is being passed on to a surviving spouse.
The high limit of the federal estate tax ensures that nearly 99% of all property owners won’t have to pay it. This is a far cry from before. Nearly 10.5% of all property owners had to pay federal estate taxes in 1977.
All federal estate taxes are owed directly to the Internal Revenue Service (IRS).
State Estate taxes
Of the 12 States and the District of Columbia that have the estate tax, the cut off limits for property vary.
- Connecticut: $3.6 million
Connecticut has an estate tax exemption cap of $15 million. If your assets are valued at over this amount, then you won’t pay any taxes on them over this limit.
- District of Columbia: $5.682 million
The DC estate tax rate is progressive. Above the $5.682 million limit, the rate maxes out at 16% for estates valued at $10.04 million.
- Illinois: $4 million
The top tax rate for Illinois is 16%. This is a progressive tax rate. This rate maxes out at $10.04 million.
- Maine: $5.6 million
The Maine tax rate maxes out at 12% for assets exceeding the value of $6 million
- Maryland: $5 million
The progressive tax rate in Maryland maxes out at 16% for assets valued at $10.04 million and up.
- Massachusetts: $1 million
The progressive tax rate in Massachusetts maxes out at 16% for assets valued at $10.04 million and up.
- Minnesota: $2.7 million
The progressive tax rate in Minnesota maxes out at 16% for assets valued at $10.1 million and up.
- Oregon: $1 million
The progressive tax rate in Oregon maxes out at 16% for assets valued at $8.5 million and up.
- Rhode Island: $1.562 million
The progressive tax rate in Rhode Island maxes out at 16% for assets valued at $10.04 million and up.
- Washington: $2.193 million
The progressive tax rate in Washington maxes out at 20% for assets valued at $9 million and up.
- Vermont: $2.75 million
The flat tax rate in Vermont is 16% for assets valued at $2.75 million and up.
- New York: $5.74 million
The progressive tax rate in New York maxes out at 16% for assets valued at $10.1 million and up.
- Hawaii: $5.49 million
The progressive tax rate in Hawaii maxes out at 15.7% for assets valued at $5 million and up.
There are other states that used to have the Estate tax after 2010, but don’t anymore. Of them,
- North Carolina and Ohio repealed the Estate tax for deaths after January 1, 2013
- Tennessee repealed the Estate tax for deaths after January 1, 2016
- New Jersey and Delaware repealed the Estate tax for deaths after January 1, 2018
All state-level estate taxes are collected by the individual states themselves and are then sent to the IRS. The difference is that these taxes are mostly spent on the state’s welfare and needs. However, the federal estate tax is spent on the overall needs of the federation.
Does It Matter Where You Live?
It matters a lot where you are living when you pass away when it comes to paying the estate taxes. That’s why there are those that try to change their residence to avoid paying estate tax. There are ways to reduce the estate tax. However, you have to do more than change your residence.
In Washington and Oregon, the residency alone isn’t required to determine if you’re subject to the Estate tax in 2019. The assets you own are also a part of it.
If you live in Oregon, your real estate, tangible property (cars and jewelry) and, intangible property (stocks) are subject to the Estate tax. If you’re not living in Oregon, then all your tangible property and real estate within the State will be taxed.
Hence, if you’re living in a state without Estate tax, but have property in one like Oregon, you will have to pay taxes on it. These things have to be taken in to consideration when you’re moving or simply selling your property to avoid taxes.
A common misconception is if you have property valued below the exclusion amount, it won’t be subject to estate tax. However, this is a huge mistake. The gross estate and the assets located in the state together determine if you are to be taxed. For instance, if you own a home valued at $11.3 million, you may think you’re exempt from the federal estate tax. However, if you have gold and jewelry, etc. worth more than $100,000, that adds up to $11.4 million. The federal estate tax will hence, apply to you.
Hence, you have to determine the total value of your estate and the locations of your assets. All of this can seem very complex at times, which is why you should get legal and professional help.
Calculating the Value of Your Estate
The Valuation of your Estate is a much more difficult and complicated process than you might think. It depends on the current fair market valuation of your property. However, it also involves a lot of other factors.
The Internal Revenue Code provides two dates as options for the date of valuation. These are the “date of death” and an “alternate valuation date”.
Fair Market Valuation
The Fair Market Value of a property is basically what it would sell for on the open market. Depending on the date that is chosen for the valuation, the price is then determined. There are a few conditions to this valuation:
- The price must be determined by buyers and sellers that have considerable knowledge about the asset.
- The buyers and sellers must be working in their own best interests. There should be no undue pressure on the evaluators.
- The buyers and sellers should be given due time to complete the transaction.
If all of these conditions are followed, then an accurate and unbiased valuation can be conducted. The reason these conditions are imposed is to counteract fraud and overvaluation or undervaluation.
Difference Between Market Value, Fair Market Value, and Appraised Value
The difference between market value and fair market value is quite subtle. The former simply refers to the price of the asset in the marketplace. However, the latter takes in to account fair market practices and considers evaluating the asset on purely objective principles.
The market value of an asset can be found on a listing. However, the fair market valuation has to be done more objectively and not based purely on buyer’s sentiment.
Appraised value is also quite different. The term refers to the value that is determined by a single party. That can usually be subject to biases. However, fair market value is determined by many different parties. Hence, this ensures more objectivity.
Fair Market Valuation is not only used to determine the value of an asset during Estate taxes. In fact, it’s used during divorce settlements, insurance claims and even during donations.
Date of Death Valuation
The Date of Death valuation concerns the date that the owner of the Estate passed away. The value of the Estate is determined by the fair market value of the assets that make up the Estate. These include
- Investment and retirement account valuations at the time of death.
- The average of the high and low prices for any stocks owned on the date of death (multiplied by the shares owned). If the death occurs on a day that the stock market is closed, the average of the highs and lows on the last day the market was open will be considered.
The fair market valuation of all business interests and real estate properties is to be determined by a qualified appraiser.
Alternate Valuation Date
The Alternate Valuation date of the assets in possession is six months after the date of death. According to the Internal Revenue Code, a personal representative can choose between the date of death or the alternate day. This is in case six months after the death of the owner, the gross value of the estate decreases.
Date of Death vs. Alternate Date
An alternate date can be chosen if the assets have lost significant value six months after the date of death. In this case, the Estate tax bill can be reduced. However, if the alternate date values are used, then all of the estate assets have to be revalued. These cannot just include the ones whose values have been reduced.
If an asset has been sold within six months after the date of death, its sales price will be used.
We’re not all made of money, even if we may have a huge Estate. It matters what cash you have on hand at the end of the day. However, if somehow you can’t pay the Estate tax, then there are a few options you can avail.
The Estate tax is payable up to nine months after your date of death. The Internal Revenue Service won’t accept a piece of the Real Estate itself. Hence, only hard cash will do. It doesn’t even deal in precious stones, a piece of stock in your business, or in any minerals you have.
When you’ve passed on, there must be a representative of the Estate or a Trustee that will have to deal with this. They will have to determine where to pay tax on the Estate from. The four options available to them are:
1. Cold Hard Cash
This is the ideal situation. If you have enough liquid cash, then you will be obligated to pay through that. The IRS likes nothing more than to collect through liquidated assets. This avoids any sort of hassle or tedious legal paperwork that can slow down the process.
Assets which are easily liquefiable like shares, and stocks; or bonds, can also be used to pay the Estate tax in 2019. Note that this is a rare circumstance, and most Estate taxes aren’t paid this way due to lack of liquid assets.
2. Life Insurance Proceeds
Life Insurance, which can be paid to a Revocable Living Trust, can be used to pay Estate taxes. These can be collected from the insurance company by the Personal Representative and the Trustee. The two are required to work together with estate planning attorneys to get the job done.
Note that if Life insurance proceeds are paid to a beneficiary, they will not be under obligation to pay Estate taxes. Hence, if you trust someone with the Life Insurance proceeds, then make sure they are to be trusted. However, if there aren’t enough other assets to pay the taxes, the IRS will go after them.
3. Selling or Borrowing Against Illiquid Assets
There can be circumstances in which an Estate doesn’t have the cash to pay taxes. In this case, the assets that are easily liquefiable can be used instead. The personal representative or the Trustee needs to make this decision. In fact, in certain cases, they are even allowed to borrow or force liquidation.
These assets can be closely held business stocks or part of the real estate itself.
This can lead to sales of the property or the assets at reduced prices. These sales are usually referred to as fire sales. The hurry is due to the nine months that the taxes are due in. This can be counterproductive since it reduces the total value of assets for the beneficiaries of the Estate.
Remember though that the IRS can grant extensions of time. These extensions have to satisfy certain requirements like undue hardship or tragedy befalling the Estate. This has to be demonstrated in a legal sense, of course. However, this means that interest will keep accruing on the unpaid balance. This will continue until the taxes are paid.
If you plan ahead, you can actually split your estate in to trusts, so that you don’t have to pay taxes on it at all. For instance, if you have an estate worth $12 million, you can split it in to two trusts. You can name one of them to your children, or to your wife. Say you split it half and half ($6 million each). Provided you’re in a state that doesn’t have a state Estate tax, you’ll be exempt completely.
5. Estate tax Elections
Estate tax elections can be used to stretch out payments of Estate taxes for years at a time. While it’s not a permanent solution, it’s an option to be availed to give you more time. To take advantage of the elections, you need to fulfill certain requirements. You need to have assets, like a family farm or a closely held business.
The rules governing the tax on these things are more complicated than a house or a big mansion. If your estate fails to meet a single requirement however, then it won’t qualify for the election. And then the tax man will be at your door in nine months.
You shouldn’t rely on the Estate tax elections in order to pay off taxes. However, you may use them to buy time and look in to other assets you can use to pay them off. These can reduce the value of the taxable estate.
Estate taxes are some of the most complicated and tedious taxes in the entire country. Location, total value of assets, exclusion value and exemption caps are all involved. If you want to determine the actual value of your Estate tax, then seek professional or legal help. It’s unwise to calculate it on your own, unless you are a legal professional.