Death Taxes—What are they, and how do they affect me?
Death Tax is a political term used when discussing estate tax and inheritance tax. Estate tax is tax imposed on a deceased person’s estate before any distribution of assets is made to the deceased person’s beneficiaries. Inheritance tax is tax imposed on the recipient beneficiaries directly (although in practice, most decedents include instructions in their estate plans requiring the estate to pay the tax on behalf of the beneficiaries). While there is currently a federal estate tax, there is no federal inheritance tax. On the state side, 14 states and the District of Columbia have estate taxes, while 6 states have inheritance taxes.
“Death Taxes” sound horrible, and the number of states that have them has fallen over the past several years. The Trump administration and Congress are currently pushing for tax reform, and the House of Representatives has passed a tax reform bill, the Tax Cuts and Jobs Act. The bill proposes a complete phase-out of the federal estate tax by 2024.
While ending federal estate tax sounds like a great idea that many people would want to rally behind, its application will only impact a small number of Americans. Under the current federal tax scheme, no federal estate tax is owed for estates valued at less than $5.49 Million per individual ($10.98 Million per married couple). Under the tax reform bill, this number will increase in 2018 to $5.5 Million ($11 Million per married couple). For estates that exceed that threshold, a 40% tax is owed on every dollar above the initial $5.49 Million. That’s a lot of money, and it is rare for an individual or couple to qualify for the federal estate tax. In fact, less than 0.2% of American estates end up owing any estate tax under the current exemption. In other words, less than 2 out of every 1000 Americans that die have to pay the federal government any estate taxes. Nor do the beneficiary recipients owe any money to the federal government for what they receive from those estates. In short, the federal estate tax has no effect on middle-class America.
What does affect many, many Americans is the benefit from another tax law that provides a step-up in basis for property held at death. Basis is the amount a person initially pays for property. When property that has increased in value is later sold, the person has taxable income on the sale. The taxable income is the amount for which the property is sold, less the basis in the property.
To illustrate what a step-up in basis means, let’s say your parents bought a few shares of Microsoft stock in the early 1990s and never sold it. Your parents then died in 2017 and left their stock to you, their only child. While your parents may have paid very little for that stock initially, the value of that stock has substantially increased over the years. As your parents’ only beneficiary in their will, you become owner of the stock. You sell the stock shortly thereafter and make a LOT of money! Is that money taxable income? Under the current tax scheme, it’s not. Because they held the asset at death, your basis in the stock automatically increases to current market value. You sell the stock at market value, and you have no taxable gain! If, however, your parents sold the stock right before death, they would have a huge amount of taxable gain. This tax benefit applies to all types of assets, whether they be stocks, bonds, real property, or even your grandpa’s baseball card collection.
The step-up in basis was meant to offset the federal estate tax. Some would argue that with no federal estate tax, there is no more logical reason or need for allowing the stepped-up basis for appreciated assets held by deceased persons. When the tax reform framework was initially released in late September, it was unclear whether this step-up in basis would survive. But the proposed tax bill keeps the step-up in basis, despite getting rid of death taxes.
The table below shows a list of states that require an estate tax and states that require an inheritance tax. While Maryland and New Jersey are the only two states to require both, New Jersey has recently voted to phase out its use of estate tax by the beginning of 2018. But it will continue to have an inheritance tax.
State Estate Tax (14+D.C.)
State Inheritance Tax (6)
District of Columbia
New Jersey (phased out by 1-1-18)
If you are looking to read further into Death Taxes, check out these blog posts from our experienced attorneys at the Goosmann Trust Law Counsel. For more information on how tax reform affects your estate plan, or for help forming a comprehensive estate plan tailored to your individual needs, contact a Sioux Falls estate planning attorney, a Sioux City lawyer, or an Omaha attorney today!