Federal estate taxes are a tax paid by a person's estate based upon the value of their property at death. The tax is 40% of value of the decedent's taxable estate in excess of the exemption amount for the year of death. The exemption amount is $12.06 million for 2022. The exemption amount is indexed for inflation annually but is scheduled to sunset on Dec. 31, 2025. On Jan. 1, 2026, the exemption amount will be reduced to less than 50% of the 2025 value. The taxes are due within nine months of the decedent's death.
How are estate taxes calculated?
The federal estate tax is imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States. The "taxable estate" is the "gross estate" of the decedent reduced by allowable deductions. The most important deduction is the unlimited marital deduction. The "gross estate" is the value of all property owned or controlled by the decedent, including probate property, non-probate property and any real estate located outside the United States.
Can estate planning reduce estate taxes?
Yes. Married couples can reduce estate taxes in three ways:
What is the unlimited marital deduction?
The unlimited marital deduction is the value of all property of any value left to your surviving spouse that is subtracted from the value of the decedent's taxable estate. If you leave your entire estate to your spouse, no estate tax is due since your taxable estate has a value of zero. An estate tax return needs to be filed to claim the benefit of the unlimited marital deduction for an otherwise taxable estate.
What is portability?
Estate tax exemption amounts are individual. Portability allows married couples to make full use of both spouses' exemptions to reduce the taxes due at both deaths. Only decedents with a surviving spouse can "port" any unused exemption amount to their spouse to be used when the surviving spouse subsequently dies. The amount transferred is called the Deceased Spouse's Unused Exemption (DSUE). Portability reduces the estate taxes owed at the surviving spouse's death since the combined amount of DSUE and their own exemption amount is available to reduce taxes on any lifetime taxable gifts and on their estate when they pass away. DSUE is determined by the year of the deceased spouse's death, so any subsequent adjustment to the exemption amount does not change it, and it is not indexed for inflation. An estate tax return needs to be filed to claim portability at the death of the first spouse.
What is a credit shelter trust?
A credit shelter trust is a type of joint revocable trust used to reduce estate taxes. While both spouses are alive, their joint trust functions like a typical revocable trust. Both spouses are the trustees. They both benefit from the trust's income and can access the trust's assets to meet their needs. The difference with a traditional joint trust comes when the first spouse dies. In a typical joint trust, the death of one of the spouses does not change the trust's structure, and the surviving spouse remains trustee for the entire trust. A credit shelter trust, however, is different. When the first spouse dies, the trust is divided into two separate trusts, called Trust A (also called the marital trust) and Trust B (also called a credit shelter trust). The A trust is a continuation of the original trust and keeps its name, so no retitling is needed. The assets transferred to the B trust need to be retitled into the name of that trust within nine months of the first spouse's death. Only the assets in the A trust will be part of the surviving spouse's taxable estate when they die.