Estate Tax (& Gift Tax)
Do I Need to Worry About It?
By Daniel Khaldarov
Estate tax primarily affects wealthy individuals and families, serving as a tax on the transfer of assets upon death. While the current federal estate tax exemption is $13.61 million per individual, this amount could be cut in half after 2025 if Congress does not renew the portion of the 2017 Tax Cuts and Jobs Act (TCJA) that doubled the estate tax exemption. In New York, the state estate tax exemption is only $6.94 million with a tax cliff that can cause your entire estate to be taxed (read below). Whether you’re planning your estate or dealing with the estate of a loved one, understanding estate tax is essential for effective financial planning. Here’s a breakdown of what estate tax is, how it works, and what you can do to minimize its impact.
What is Estate Tax?
Estate tax is a tax imposed on the transfer of assets upon an individual’s death. This tax applies to the total value of a deceased person’s estate, which can include real estate, investments, bank accounts, and personal property.
A critical distinction to understand is between the taxable estate and the probate estate:
Taxable Estate: This is the total value of all assets owned by the deceased at the time of death, minus any allowable deductions, such as debts, funeral expenses, and charitable contributions. The taxable estate is used to determine whether estate tax is owed and how much is owed. It includes assets that may not necessarily go through probate, such as certain life insurance policies, retirement accounts, and assets held in trusts.
Probate Estate: This includes only the assets that are subject to probate, which is the legal process through which a deceased person’s will is validated and their assets are distributed. The probate estate typically consists of assets that are solely owned by the decedent and that do not have a designated beneficiary, such as real estate, personal property, and bank accounts solely in the decedent’s name. Assets held in joint tenancy, in the name of a trust, or those with designated beneficiaries (like life insurance or retirement accounts) usually bypass probate and are not included in the probate estate.
Understanding the difference between these two estates is crucial for estate planning, as it affects both the tax liability and the distribution of assets after death.
Key Features of Estate Tax
Exemption Amount: The federal estate tax exemption is the threshold below which no estate tax is owed. As of 2024, this exemption is set at $13.61 million per individual. This means that estates valued below this amount are not subject to federal estate tax. However, many states, including New York, have their own estate tax exemptions, which can be significantly lower. For instance, New York’s estate tax exemption for 2024 is $6.94 million.
Tax Rate: For estates that exceed the exemption limit, the tax rate is quite steep. The federal estate tax rate is 40%. In New York, the estate tax rates range from 3.06% to 16%, depending on the value of the estate (see page 6 of Form ET-706 for a complete table of New York estate tax rates)
NY Estate Tax Cliff: A significant feature of New York’s estate tax system is the “estate tax cliff.” This means that if an estate exceeds the exemption amount by 5%, the entire estate may be subject to estate tax, not just the portion above the exemption. For example, if an estate is valued below $6.94 million, it may not owe any estate tax. However, if the estate is valued at over $7.287 million, the estate tax will apply to the value of the entire estate, which can lead to a substantial tax liability. This cliff creates a strong incentive for estate planning, as careful strategies can help keep the estate’s value below the threshold.
Filing Requirements: Executors of estates are responsible for filing an estate tax return if the gross value of the estate exceeds the exemption limit.
Federal Filing: The federal estate tax return is filed using Form 706. This form is required when the estate’s value exceeds the federal exemption threshold. Form 706 must be filed within nine months of the decedent’s death, but an extension may be requested.
New York State Filing: For estates exceeding the New York exemption amount, a separate state estate tax return, known as Form ET-706, must be filed. This form is similar to the federal return but specifically applies to New York’s estate tax laws. The filing deadline is also within nine months of the decedent’s death.
The Tax Cuts and Jobs Act and Its Implications
The Tax Cuts and Jobs Act (TCJA), enacted in December 2017, significantly impacted estate tax by nearly doubling the federal estate tax exemption. As previously mentioned, the exemption is set at $13.61 million per individual for 2024. However, it’s important to note that the provisions of the TCJA, including the increased exemption amounts, are set to sunset in 2025.
If Congress does not act to extend the higher exemption levels, the federal exemption will revert to approximately $5 million (adjusted for inflation) per individual, meaning that many more estates may become subject to estate tax after 2025. This potential decrease in the exemption creates a pressing need for individuals to review and possibly revise their estate plans to take advantage of the current favorable exemption levels before they potentially diminish.
Special Considerations
Portability: For married couples, the unused federal estate tax exemption of the deceased spouse can be transferred to the surviving spouse. This is known as “portability.” To take advantage of this benefit, the surviving spouse must file a federal estate tax return (Form 706) within nine months of the deceased spouse’s death, even if the estate is below the exemption amount. However, it’s important to note that portability is unavailable for New York estate tax, meaning the state does not allow the transfer of the unused exemption from one spouse to another.
Marital Deduction: The marital deduction allows for an unlimited transfer of assets between spouses without incurring estate tax. This provision can help couples maximize their wealth transfer without immediate tax consequences. However, keep in mind that the value of the assets transferred will be included in the surviving spouse’s estate when they pass away.
Charitable Deduction: Gifts made to qualified charitable organizations are exempt from estate tax. This means that charitable contributions can reduce the overall value of the estate, which may lower the estate taxes owed. For those who are passionate about philanthropy, incorporating charitable giving into your estate plan can be a tax-efficient strategy.
Difference Between Form 706 (Estate Tax), Form 1041 (Estate Income Tax), and a final Form 1040 (Income Tax)
While Form 706 (federal) and Form ET-706 (NY state) are used to report estate taxes, Form 1041 is the tax return for estates and trusts that are required to file income tax returns. Form 1041 is used to report income generated by the estate after the individual’s death, including interest, dividends, and rental income. Additionally, a regular Form 1040 still has to be filed for the part of the year that the decedent was still alive.
At the Law Office of Daniel Khaldarov, I can help you with filing any of these forms.
Strategies for Minimizing Estate Tax
Use the Annual Gift Exclusion: The annual gift tax exclusion in 2024 allows individuals to gift up to $18,000 per recipient per year without incurring gift tax. This strategy can help reduce the overall value of your estate over time. If you are married, you can file a Form 709 to gift up to $36,000 per recipient per year by electing to split gifts. This amount increases every year with inflation.
Establish Trusts: Trusts can be an effective way to manage and protect your assets while minimizing tax liabilities. Irrevocable trusts, in particular, can remove assets from your taxable estate.
Review and Update Your Estate Plan: If you are a high net-worth individual, regularly reviewing your estate plan is crucial, especially after significant life changes.
Consult a Professional: Navigating estate tax regulations can be complicated. Working with an estate planning attorney or tax professional can provide tailored strategies to meet your specific needs.
What About Gift Tax?
In addition to estate tax, gift tax plays a crucial role in managing wealth transfers during your lifetime. The gift tax is a federal tax on transfers of money or property made while the giver is still alive, intended to prevent individuals from avoiding estate tax by giving away their assets before death. Understanding how gift tax works can help you minimize potential tax liabilities and take advantage of tax-free transfers.
Annual Gift Tax Exclusion
The gift tax is typically avoided for most gifts made under the annual gift tax exclusion. As of 2024, individuals can gift up to $18,000 per recipient per year without triggering any gift tax. This means you can give $18,000 to as many people as you wish, and these gifts will not count against your lifetime gift and estate tax exemption.
For married couples, each spouse can give $18,000 to the same individual, effectively allowing them to gift up to $36,000 per person annually without tax consequences. These gifts reduce the taxable value of your estate over time, making the annual exclusion an important tool for estate planning.
Lifetime Gift Tax Exemption
In addition to the annual exclusion, there is a lifetime gift tax exemption that is unified with the estate tax exemption. As of 2024, this lifetime exemption is $13.61 million per individual, meaning that any gifts exceeding the annual exclusion count toward this limit.
For example, if you gift $20,000 to a single person in one year, $2,000 (the amount exceeding the $18,000 annual exclusion) will count against your lifetime exemption. Once you exceed your lifetime exemption, any additional gifts will be subject to the gift tax, which is taxed at 40%.
Filing Gift Tax Returns
If you make gifts that exceed the annual exclusion, you are required to file Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return. However, this doesn’t necessarily mean that you’ll owe gift tax—it simply allows the IRS to track how much of your lifetime exemption you’ve used. Form 709 must be filed along with your regular income tax return by April 15 of the year following the gift.
Gifts Between Spouses and Charitable Gifts
Certain gifts are entirely exempt from gift tax, including:
Gifts between spouses: You can transfer an unlimited amount of money or property to your spouse without incurring gift tax, as long as they are a U.S. citizen.
Charitable gifts: Gifts to qualified charitable organizations are not subject to gift tax, and they may also provide a deduction for income tax purposes, depending on the type and size of the gift.
Contact the Law Office of Daniel Khaldarov for Help
Understanding estate & gift tax is essential for effective estate planning, especially for those with significant wealth. By familiarizing yourself with how estate & gift tax works, the necessary tax forms, and implementing strategies to minimize its impact, you can ensure that your loved ones are well taken care of and that your financial legacy is preserved. Proactive planning and professional guidance can make a significant difference in navigating the complexities of estate tax, allowing you to focus on what truly matters—caring for your family and achieving your financial goals.
If you need someone who can create an estate plan to minimize or eliminate your estate tax burden, contact the Law Office of Daniel Khaldarov today.
