Introduction
Estate tax, also known as inheritance tax, is a tax imposed on the transfer of property from the deceased to the beneficiaries. The estate tax can be one of the most significant expenses for many families. In the United States, estate tax is levied by the federal government and some states. The tax rate is progressive, with rates ranging from 18% to 40%. Thankfully, there are a number of exemptions to estate tax that can help families reduce their tax burden. This article will discuss the exemptions to estate tax and help families understand how to take advantage of them.
Exemption on Spousal Transfers
One major exemption to estate tax applies to spousal transfers. When a husband or wife dies, their entire estate is transferred to the surviving spouse without incurring any estate taxes. The exemption is not limited to cash transfers but includes other property such as homes, investments, and other valuables. However, this exemption does not fully eliminate estate tax. The surviving spouse can only use their share of the unified estate tax credit to exempt a certain amount of their estate from tax liability.
Unified Estate Tax Credit
The unified estate tax credit serves as a credit that can be applied against the estate tax for individuals and couples. This exemption helps to reduce the amount of estate tax that would otherwise be due. The unified estate tax credit was brought into effect under the Tax Cuts and Jobs Act, 2017 (TCJA). Under this act, the estate and gift tax exemption increased from $5.49 million in 2017 to $11.4 million for individuals and $22.8 million for married couples. These values are adjusted for inflation, and for 2021, the exemption stands at $11.7 million for individuals and $23.4 million for couples.
Portability of the Unified Estate Tax Credit
Portability of the unified estate tax credit is a feature that stands to benefit spouses in a more significant way. Before portability of the unified estate tax credit was introduced, married couples had to set up trusts or other arrangements to keep the exemption separate. With portability, a spouse can transfer any unused portion of their estate tax exemption to their surviving spouse. This allows the surviving spouse to have a higher exemption, allowing them to transfer more property without incurring any estate tax.
Charitable Contributions
Charitable contributions made during an individual’s lifetime or through their estate can be used to reduce the taxable value of their estate. By making charitable contributions, families can reduce the amount of estate tax they have to pay. One thing to keep in mind is that the charitable organization must be a qualified 501(c)(3) organization. The estate will also receive a tax deduction for the contribution.
Qualified Family-owned Business Interest (QFOBI) Deduction
This exemption applies to families who own businesses that have been passed down from generation to generation. A Qualified Family-owned Business Interest (QFOBI) deduction is a deduction an estate can claim for a portion of the value of a family-owned business. To qualify, the family member who owns the business must have at least a 50% interest in the business prior to death. Additionally, the business must have been in existence for five years and must continue to exist for another five years after the owner’s death. The maximum deduction allowed is $1.58 million.
Exemption on Life Insurance Proceeds
Life insurance is a popular way for people to ensure that their loved ones are taken care of after they pass away. Most people are not aware that life insurance proceeds are generally income tax-free, and estate tax-free under certain circumstances. The IRS does not include the proceeds of a life insurance policy in the calculation of an estate’s gross value, as long as the policy was not owned by the decedent at their time of death. If the policy is owned by the decedent, the proceeds are included in their taxable estate. One way to avoid this scenario is by transferring ownership of the policy to a loved one, an irrevocable trust or a business entity hence avoiding being part of an estate.
State Estate Tax Exemptions
Finally, some states have their estate tax, separate from the federal estate tax. The estate taxes in these states come in the form of estate taxes, inheritance taxes, or both. California, Tennessee, Florida, and Nevada, among others, have no state estate taxes. New Jersey and Oregon have some of the highest state estate tax rates in the country which starts from 14.8% to 16%. State estate taxes usually have lower exemption thresholds than the federal exemption. Review referring to the relevant state government from time to time is crucial to keep the tax planning updated with the latest changes.
Conclusion
In conclusion, estate tax can be a significant expense for many families. However, by taking advantage of the exemptions discussed above, families can reduce their tax burden. Portability of the unified estate tax credit and qualified family-owned business interest deductions are just two examples of the exemptions that can be used to reduce the taxable value of an estate. Additionally, families should seek to understand state estate tax laws as these taxes come on top of the federal estate tax when applicable. By working with tax planning professionals, families can better understand the exemptions available to them and develop a plan that will help them minimize estate tax liability.
There are some allowable inheritance tax exemptions for estates and the beneficiaries, but there are not many. In some states such as Kentucky, immediate relatives are exempt from paying any inheritance tax at all, no matter the value of the estate. However, that estate would still be subjected to Federal taxes.
Exemptions can be beneficial if families take part in inheritance tax planning before hand. In some cases, it may benefit the benefactor and the beneficiary to transfer property before death. Inheritance tax planning can end up saving a large amount of money through an inheritance tax exemption. For 2010, the Federal Estate tax does not apply. However, in 2011, inheritance tax planning will involve a lot of factors, not the least of which is allowable exemption amounts.
The value of an estate must fall below one million dollars in 2011 in order to qualify for an inheritance tax exemption. Previously, in 2009, that maximum estate value for an inheritance tax exemption was set at over three and a half million. Â In 2011, inheritance tax planning would include reducing the value of an estate to below one million dollars in order to avoid paying a larger percentage of inheritance taxes and estate taxes. If an estate is valued at higher than one million dollars, it will be subjected to a fifty five percent tax for any amount above the inheritance tax exemption.
In 2010, the entire value of an estate is currently under the Federal inheritance tax exemption because the law that governs those taxes was repealed.  Inheritance tax planning for those that inherit property in 2010, should include saving for inheritance taxes that may be imposed when the 2011 law goes into effect. Even though there is currently a one hundred percent inheritance tax exemption, the law may allow estate taxes and inheritance taxes to be retroactive to when the law was repealed. Under the law that goes into effect in 2011, exemptions are allowed for  estates with a much lower value than those that enjoyed exemptions in the past.
In addition to the federal inheritance tax exemptions, each state also has allowable exemptions. Inheritance tax planning should take the unique and specific state inheritance and estate laws into account, in order to maximize the possible inheritance tax exemptions. In addition, the value of estates that fall below a certain threshold, often enjoy an inheritance tax exemption. Most of these exemptions apply to Federal taxes and many also apply to state taxes. Those that enjoy an inheritance tax exemption on the federal level, may find that  exemption is not allowed according to state laws. It is important that beneficiaries follow both state and Federal tax laws when taking part in inheritance tax planning.
