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Estate and gift taxes explained

On Behalf of | Oct 19, 2021 | Estate Planning - Estate Administration & Probate

The estate tax is a one-time tax that may be assessed against a person’s estate at the time of their death. There is currently a federal estate tax, and some states also have a separate state estate tax, including Maryland. At the most basic level, if the total value of a deceased person’s assets minus liabilities at the time of death (the “net estate”) is over the allowable exemption amount, the estate tax will be assessed against that person’s estate. If an estate tax is due, the payment is typically made from the net estate prior to distribution to any beneficiaries.

On the federal level, there is an estate tax and a gift tax; however, each person is given a combined exemption amount from the federal estate and gift tax (the “Federal Exemption”). In addition, each person is also allowed to make gifts up to a certain amount to each recipient every year ($15,000 for 2021) without having to use their Federal Exemption (the “Annual Exclusion”). Any gifts over the Annual Exclusion made to a recipient other than a spouse each year will reduce the Federal Exemption and have to be reported to the IRS on a gift tax return (Form 709) so there is a record of how much Federal Exemption remains upon death.

The Federal Exemption has increased ever since 1997. At that time, the Federal Exemption was a mere $600,000 per person. If the Federal Exemption was not used (aka applied) within nine months of a person’s date of death, it was gone forever. Today, because of the Tax Cuts and Jobs Act that went into effect in 2018, the current Federal Exemption is at an all-time high of $11.7 million per person and this is indexed for inflation each year until 2026, when the amount is scheduled to drop back down to approximately $6.5 million per person.

Simultaneously, the maximum federal estate and gift tax rate has decreased since 1997. In 1997 the tax rate was 55% and in 2021 is down to 40%. Effectively, this means that if a deceased person’s net estate is over the Federal Exemption, any amount over the Federal Exemption is taxed at a rate of 40%.

Maryland’s estate tax exemption rate is currently $5 million per person, pursuant to legislation that was enacted in 2018 (the “Maryland Exemption”); however, Maryland does not have a gift tax. Also unlike the Federal Exemption, the Maryland Exemption is not indexed for inflation. The Maryland estate tax rate is anywhere between 10% and 16% for estates over the Maryland Exemption. The tax rate increases the larger the estate is over the Maryland Exemption.

Assets gifted to spouse during lifetime and inherited by spouses upon death generally are not subject to the federal or state estate tax. This is another exemption afforded just to married couples, known as the marital deduction. Another exemption from the federal and state estate tax is any gifts during lifetime or transfers upon death that are made to a qualified charity. Finally, under the current laws, there are also certain types of trust assets that will be considered excluded from your taxable estate. A good example of this is an irrevocable life insurance trust, designed to hold a life insurance policy for the purposes of removing the value of the life insurance from your estate (as it is the death benefit of a life insurance policy and not the cash or surrender value that is included in the valuation of your taxable estate).

With a current Federal Exemption of $11.7 million, most people do not have to worry about the assessment of a federal estate tax upon their death. It is something to watch, however, as the most recent proposal coming out of the House Ways and Means Committee from September 2021 proposes to reduce the Federal Exemption down to $5.5 million now.

If you have further questions regarding the federal or state estate tax, or you are interested in learning about ways to reduce or mitigate the assessment of these taxes, contact us to schedule a free 15-minute consultation.