Myths of the Estate Tax

If you think you can avoid the federal estate tax, ­­you're probably right. The federal estate tax applies to Americans only if their estates total more than $11.7 million for individuals and $23.4 million for couples. For these very wealthy families, the rate can go as high as 40%.

Only 4,100 estate tax returns were filed in 2020, and only about 1,900 estates were deemed taxable by the IRS. That means that less than 0.1% of the 2.8 million people who are expected to die this year will actually pay estate tax, according to the Tax Policy Center. You may still get hit by a state estate tax, but it's unlikely. Most states have neither an estate tax, levied on the actual estate, nor an inheritance tax, assessed against those who receive an inheritance from an estate.

Indeed, the number of jurisdictions with such levies has been dropping. State taxes are collected only above certain wealth thresholds. It's relatively uncommon for estates and inheritances to actually be taxed, even though state estate taxes and/or inheritance taxes kick in at lower thresholds than the federal estate tax in the states where they exist.

What is your state's situation?

Twelve jurisdictions have just an estate tax: Connecticut, Hawaii, Illinois, Maine, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington and the District of Columbia. The states with just an inheritance tax are Iowa, Kentucky, Nebraska, New Jersey and Pennsylvania — those states tax what an heir receives as the beneficiary of an estate. Maryland alone levies both an inheritance and an estate tax. Spouses and certain other heirs are typically excluded by states from paying inheritance taxes. There is no federal tax on inheritances.

The rates on a state estate or inheritance tax vary. For example, New York has an estate tax of from 3.06% to 6% on estates worth more than $5.9 million. Connecticut has an estate tax of from 10.8% to 12% on estates worth more than $7.1 million. Nebraska has an inheritance tax of up to 18%. (Rates change over time, so be sure to check for the latest numbers in your jurisdiction.)

Heirs can have an extra advantage when they inherit appreciated assets, such as stocks and mutual funds. When they sell such an asset, the taxable gain is generally computed favorably based on the value of the asset at the time of the original owner's death rather than the value when the original owner purchased it. This "step-up" results in a smaller taxable gain for the heir.

Of course, depending on the size of your estate and your location, you should prepare for whatever estate taxes you'll face. But the key is to not make any assumptions. Don't try to avoid a tax that may have little or no effect on what you leave your heirs. As with any estate planning issues, work closely with financial and legal professionals.

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