The Federal Government and many States will tax assets transferred at death if those amounts exceed a certain amount. It's essential to understand the basics of the estate tax exemption and how it may or may not impact you or your loved ones.
What is the Estate Tax Exemption?
The United States taxes amounts that are in someone's "taxable estate" at their death if they exceed a specified limit. In 2023, the Federal limit is $12.93 million and the Hawaii exemption is $5.49 million for an individual. That means if the transfer exceeds this threshold, the estate will have to pay a tax of up to 40% on the excess. There are other considerations which we discuss in other posts, but this is the basic rule.Who Pays the Estate Tax?The estate tax is paid from your estate, and is not paid out of pocket by your beneficiaries. That means any estate tax will come out of the of the assets they will receive before they are transferred.
Why Should "Regular People" Care?
Right now, the estate tax threshold is very high and affects a small number of American households. In 1997, however, the exemption was only $600,000. In 2025, this exemption is set to be lowered to $7 million, barring any legislative changes.
What's the Effect?
The estate tax exemption can have significant implications for high earners, business owners, and wealthy families. These individuals need to plan their estates carefully to minimize the tax impact on their heirs. Strategies include creating "bypass" trusts, which are a common way of trying to mitigate the effect of estate tax, removing assets from your taxable estate while you are alive through irrevocable trusts, gifting strategies, transfer assets to your spouse, or creating charitable trusts.
Many people also forget that their two most valuable assets - their IRAs and their personal residence - are part of their taxable estate. Failing to plan for estate tax may mean your beneficiaries receive less, and may trigger the need to sell retirement accounts or real estate to pay the estate tax due.While the tax only applies to a small percentage of estates right now, that might not always be the case, especially for young couples. Almost everyone can benefit from creating an estate plan that lets them take advantage of ways to lessen their exposure to Federal and State estate tax.