You pay taxes throughout your life, but the event of your death can also be a taxable one if you have been very successful financially. There is an estate tax in place on the federal level, and it can be a major factor when you are engaged in the process of inheritance planning.
The federal estate tax can erode the wealth that you are leaving behind to your heirs considerably. At the time of this writing in 2013, the maximum rate of the tax is 40 percent. The amount of the federal estate tax exclusion at the present time is $5.25 million.
This figure is derived from a base of $5 million that was put into place for 2011. There are annual adjustments for inflation. Next year you may see another adjustment for inflation resulting in an exclusion amount that is a bit higher than $5.25 million.
Because of the exclusion or credit, transfers totaling up to $5.25 million can be made free of taxation. The rest would be subject to a death tax that carries a 40 percent maximum rate.
Here in the state of New York we also have a state level estate tax. The top rate is 16%, and the amount of the exclusion is $1 million.
Estate Taxes & Spouses
Estate tax responsibility is calculated based on the value of inheritances that you leave to people other than your spouse. Fortunately, we have an unlimited spousal estate tax deduction. This enables your spouse to receive an unlimited inheritance from you free of death taxes, assuming your spouse is an American citizen.
This unlimited deduction is not afforded to non-citizen spouses. Inheritances received by noncitizen spouses are tensely taxable.
The unlimited deduction exists on both the state and the federal levels.
This does not mean that you don’t have to implement estate tax efficiency strategies if you are married. The reason why the powers that be are not especially concerned about allowing unlimited spousal inheritances is because they will get their money eventually.
Let’s say that you leave everything to your spouse using the unlimited marital deduction. That’s great, your spouse inherits all of your property tax-free.
However, what comes next? Clearly, your spouse is going to die someday. At that time, the estate tax will still be applicable as your spouse leaves inheritances to others, presumably your children.
One final thing we would like to mention in closing is that the federal estate tax exclusion is portable. You are entitled to a $5.25 million exclusion, and your spouse also has his or her own $5.25 million exclusion.
If you were to predecease your spouse, he or she could use his or her own exclusion and your exclusion. Using this year’s figures, that would result in a total exclusion of $10.5 million.