Federal Estate Tax: Current State of the Law

When an individual dies, any assets they own could be subject to federal estate tax. However, under today’s laws, very few estates—only two in a thousand—are likely to pay federal estate tax. That figure could change significantly with the new administration in Washington, D.C., but for now, let’s focus on the current state of federal estate tax law.

What is Federal Estate Tax, and Who Pays It?

Federal estate tax applies when property is transferred upon the owner’s death. Established in 1916, the tax was designed to prevent the income of the wealthiest individuals from accumulating and passing from generation to generation, completely untaxed. The tax is owed by the estate, not heirs; payment of the tax is taken out of estate funds before estate assets are distributed to heirs.

The reason that so few estates end up owing federal estate tax is that the tax only applies to that portion of the estate’s value over and above an exemption level established by federal law. Just 20 years ago, the exemption was $650,000 per person. By 2016, it had increased to $5.45 million per person, meaning only estates above that amount were subject to the estate tax.

However, the federal Tax Cuts and Jobs Act (TCJA) enacted in 2017 roughly doubled the estate tax exemption—at least for a while. The exemption is indexed annually for inflation. As of 2021, the estate tax only applies if the assets of a deceased individual exceed the exemption amount of $11.7 million dollars. For couples, the exemption is doubled. If one spouse dies and their estate does not use up their entire exemption amount, the unused exemption is portable to the other spouse. In other words, the unused amount of the deceased spouse’s exemption is tacked on to the exemption amount of the surviving spouse.

A careful review of your estate plan may reveal ways to minimize exposure to estate tax.

What is the Federal Estate Tax Rate?

The top federal estate tax rate is 40% for estates with taxable assets in excess of one million dollars. However, out of the 0.2% of American estates that will owe estate tax in 2021, few will pay anything close to that. The lowest estate tax rate is 18%. For estates in all but the lowest estate tax tier, the estate will pay a base amount of tax, plus a percentage of the taxable estate.

For example, let’s assume an individual dies with an estate worth $12,000,000. After the exemption amount of $11.7 million dollars, a taxable estate of $300,000 remains. That amount would place the estate in the 34% tax rate tier. For that tier, there is a base tax of $70,800. In addition, the estate would pay 34% of the taxable amount of $300,000, or $102,000. Between the base tax and that percentage, the estate would owe estate tax of $172,800.

If you think your estate might be subject to estate tax, and are curious about what tier your estate might fall into, you can view the tiers below:

Column A
Taxable Amount Over
Column B
Taxable Amount Not Over
Column C
Tax on Amount in Column A
Column D
Rate of Tax on Excess of Amount in Column A
$0 $10,000 $0 18%
$10,000 $20,000 $1,800 20%
$20,000 $40,000 $3,800 22%
$40,000 $60,000 $8,200 24%
$60,000 $80,000 $13,000 26%
$80,000 $100,000 $18,200 28%
$100,000 $150,000 $23,800 30%
$150,000 $250,000 $38,800 32%
$250,000 $500,000 $70,800 34%
$500,000 $750,000 $155,800 37%
$750,000 $1,000,000 $248,300 39%
$1,000,000 ------------ $345,800 40%

What Assets are Included in a Taxable Estate?

In order to determine the taxable estate of a deceased person (decedent), it is necessary to consider the estate’s gross assets, less certain deductions. Gross estate assets typically include:

  • All financial assets such as stocks, bonds, mutual funds, and bank accounts;
  • Real estate, such as homes, rental properties, and land;
  • Other tangible property, such as art and collectibles;
  • Interests in certain property, including the decedent’s share of jointly owned assets;
  • Life insurance benefits from policies that the decedent owned.

The value assigned to estate assets is fair market value, rather than what the decedent paid for an item. Fair market value is defined by the Internal Revenue Service as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”

Permissible deductions from the gross estate include:

  • An unlimited deduction for transfers to a surviving spouse or for the support of a minor child;
  • Debts of the estate;
  • Funeral expenses;
  • Legal and administrative fees;
  • Charitable bequests;
  • Losses during estate administration;
  • Estate tax paid to states.

Ohio, like most states, does not have an estate tax. (Jurisdictions that do impose an estate tax include the District of Columbia and the states of Washington, Oregon, Hawaii, Minnesota, Maryland, Illinois, Maine, Massachusetts, Connecticut, Rhode Island, and Vermont.)

Income in Respect of Decedent and the Estate Tax Deduction

Many estates are entitled to income after the death of a decedent, such as for a sale of assets that had not closed before the death. The Internal Revenue Service refers to such income as “Income in Respect of Decedent,” or IRD. Large estates that would be subject to the estate tax are particularly likely to have IRD.

In order to avoid double federal taxation (income tax on the IRD, plus estate tax), the Internal Revenue Service created the estate tax deduction. This deduction allows the estate to deduct that portion of the estate tax paid for income in respect of the decedent from the estate tax on that income.

Will Estate Tax Law Be Changing Soon?

There are often proposed changes to tax law, including estate tax law, when a new administration takes office. That is likely to happen with the Biden administration as well. It is unclear as of this writing exactly what form changes might take—and whether proposed modifications of estate tax law are ultimately enacted.

That said, statements now-President Biden made during the campaign tend to suggest that any changes to the law will not be favorable to the wealthy. We’ll discuss some of President Biden’s proposed changes to tax law in an upcoming blog post. For the time being, the best way to avoid your estate being saddled with estate tax is to work with an experienced estate planning attorney to ensure that you are taking advantage of every possible way to reduce your taxable estate.

If you have questions about the current state of the federal estate tax, or likely changes to the law, we invite you to contact Gudorf Law Group to schedule a consultation.