You should gain a good understanding of the potential taxes that can be levied on your estate when you are developing a plan. We will provide an explanation in this post, and we will start by clearing up some confusion about an estate tax and an inheritance tax.
Two Different Types of Taxes
People sometimes use the terms “estate tax” and “inheritance tax” interchangeably as though they describe the same tax. This assumption is understandable, but in fact, they are two different types of taxes.
An inheritance tax is levied on distributions to each inheritor when an estate is being administered, but close relatives are typically exempt. There is just one imposition of an estate tax on the entire estate before it is transferred to the beneficiaries.
There is no inheritance tax on the federal level in the United States, but there are six states that have state-level inheritance taxes. These states are Iowa, Pennsylvania, New Jersey, Kentucky, Maryland, and Nebraska.
The Iowa inheritance tax has been repealed, but a reduced tax is still in place until 2025.
Though there is no inheritance tax in New York, if you inherit property that is located in one of the states with an inheritance tax, it would be applicable even if you do not live in the state.
New York State Estate Tax
New York is one of 12 states in the union that have state-level estate taxes, and the exclusion is $5.93 million in 2021. The exclusion is the amount that can be transferred tax-free, and the estate tax would potentially be levied on the remainder.
Here in New York, we have a rule that may not be fair, but it is a fact of life. If the value of your estate exceeds 105 percent of the exclusion amount, you cannot use the exclusion. The entirety of your estate would be subject to the tax. This is referred to as the New York estate tax “cliff.”
Three-Year Clawback Provision
There is no gift tax per se in New York, but there is an impediment to lifetime gift giving. If you transfer assets out of your own name at less than fair market value within three years of your passing, the value of the resources would be added to your estate for tax purposes.
Federal Estate and Gift Tax
In addition to these state-level taxes on inheritances, we have a federal estate tax as well. Most people do not have to pay the tax because there is a robust exclusion.
At the end of 2017, the Tax Cuts and Jobs Act was enacted, and a provision contained within it raised the estate tax exclusion to a record high level. In 2018, it was set at $11.18 million, and this was essentially a doubling of the existing $5.49 million exclusion.
There have been inflation adjustments since that time, and this year, the exclusion is $11.7 million. The aforementioned provision is going to expire at the end of 2025, and on January 1, 2026, the exclusion is going to revert back to $5.49 million.
This tax carries a maximum rate of 40 percent, so it can take a huge bite out of your legacy if you are in rarefied financial company.
There is an unlimited marital estate tax deduction, so you can transfer any amount of property to your spouse free of taxation. One caveat is the fact that the deduction is only available to American citizens.
On the federal level, there is a gift tax, and it is unified with the estate tax. The multimillion dollar exclusion applies to lifetime gifts and the estate that will be transferred after your passing.
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If taxation is a source of concern for you, we can help you implement an estate tax efficiency strategy. Of course, if your estate will not be large enough to be taxed, we can work with you to develop an approach that is ideal for you and your family.
You can set up a consultation at our Manhattan, NY estate planning office if you call us at 212-973-0100, and you can fill out our contact form if you would rather send us a message.