Common Questions about Estate Planning and Taxes: Part I

Many people have questions about estate planning and federal taxes. Listed below are common questions about estate taxes, gift taxes, forms to file, etc. Every person should know what to do when someone dies and the tax consequences that are involved.

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1.  What are estate taxes?

Estate taxes are the taxes on a person’s right to transfer property at his death. It is made up of everything the person owns or has interest in at the date of his death.[1] Generally, the total value of all of those items is included in the person’s gross estate; the value is the fair market value of the items.[2] The Internal Revenue Service (“IRS”) considers estate assets to be interests in assets including, but not limited to: real estate, stocks, bonds, cash, interests in life insurance or annuity contracts, retirement accounts, and personal property.[3]

After the gross estate is computed, certain deductions are allowed to calculate the taxable estate.[4] Once the taxable estate is calculated, the value of lifetime taxable gifts is added to the number and the tax is computed. The tax is then reduced by the available unified credit.[5]

If the gross estate of the decedent, increased by the decedent’s adjusted taxable gifts and specific gift tax exemption, is valued at more than the filing threshold ($13.61 million for 2024; double for married couples) for the year of the decedent’s death, a filing of the estate tax return is required.[6] The current federal estate tax rates range from 18% to 40%.[7]

Several states also impose a state estate tax and inheritance tax. Currently, 12 states and the District ofColombia impose a state estate tax, and 6 states impose an inheritance tax. Fortunately, Texas does not impose any state estate tax or inheritance tax.[8]

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2. What is the difference between estate taxes and gift taxes?

While estate taxes are taxed on a person’s estate when he passes, gift taxes are generally taxed during life on an annual basis. Every year, an individual can make a gift up to the annual gift tax exclusion amount for each person he or she wishes to give a gift without having to pay gift tax or file a federal gift tax return.[9] The limit for 2024 is $18,000. Any gift over this amount must be reported on an individual’s gift tax return,[10] which is Form 709. However, the amount of the gift over the exclusion will be deducted from the individual’s lifetime estate tax exemption ($13.61 million in 2024), so he will not have to pay any taxes until he exceeds the lifetime exemption amount.

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3. What taxes need to be filed when someone dies?

Generally, two things must be done when someone dies: (1) filing the decedent’s final income tax return, and (2) if applicable, filing the decedent’s estate tax return.

According to the IRS, the representative of the decedent has until April 15th of the year following the taxpayer’s death to file a final Form 1040. The representative filing the tax return is named in the decedent’s will or appointed by the court.[11] In the event that the decedent was married at the time of his death, the surviving spouse can file a final joint federal tax return for the last year in which the decedent was alive.[12] If the decedent does not have a surviving spouse or appointed representative, a personal representative will file the final return.[13]

The estate tax return of the decedent, known as Form 706, must be filed if “the gross estate of the decedent who is a U.S citizen or resident, increased by the decedent’s adjusted taxable gifts and specific gift tax exemption,” exceeds the lifetime estate and gift tax exemption ($13.61 million for 2024).[14] The form must be filed no later than 9 months from the decedent’s date of death (but the deadline can be extended for an additional 6 months).[15]

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4. Will I owe any estate taxes when I die?

Generally, if a person dies in 2024, he will only owe federal estate taxes if his estate is worth more than $13.61 million. According to data research from 2015, 99.8% of estates owe no estate tax at all.[16] That means that only 0.2% of Americans owe federal estate taxes when they die. Because the lifetime estate and gift tax exemption is so large (and most people’s estates do not exceed such amount), most people do not owe federal estate taxes.

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5. If I am the beneficiary of a life insurance policy, what taxes will I owe?

In most cases, the beneficiary of a life insurance policy will not owe any taxes on the proceeds from the policy. Such proceeds are generally not included in the beneficiary’s gross income.[17] However, if the beneficiary receives any interest, it is taxable and should be reported as interest received.[18]

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Conclusion

Knowing your federal tax obligations is essential when addressing your estate planning. Taking the appropriate steps and filing any necessary forms with the IRS during life and after death will save both time and money. If you would like more information on your tax obligations, or if you have more questions about estate planning, contact Montgomery Legal today. Schedule a Consultation or call (214) 432-6100.

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[1] Estate Tax, available at https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax.

[2] Id.

[3] Estate Taxes: Who Pays, How Much, and When, U.S. Bank, available at https://www.usbank.com/wealth-management/financial-perspectives/trust-and-estate-planning/estate-taxes.html.

[4] See Estate Tax, supra note 1.

[5] Id.

[6] Id.

[7] Id.

[8] Andrey Yushkov, Does Your State Have an Estate or Inheritance Tax, Tax Foundation (October 2023), available at https://taxfoundation.org/data/all/state/state-estate-tax-inheritance-tax-2023/.

[9] See Estate Taxes: Who Pays, How Much, and When, supra note 3.

[10] Id.

[11] How To File a Final Tax Return For Someone Who Has Passed Away, available at https://www.irs.gov/newsroom/how-to-file-a-final-tax-return-for-someone-who-has-passed-away#:~:text=Usually%2C%20the%20representative%20filing%20the,will%20file%20the%20final%20return.

[12] Filing Final Tax Returns for the Deceased, Texas Financial Advisory, available at https://www.texasfinancialadvisory.com/resource-center/tax/death-is-noexcuse#:~:text=If%20you%20file%20the%20return,this%20return%20per%20IRS%20guidelines.

[13] See Smith, supra note 11.

[14] Frequently Asked Question on Estate Taxes, available at https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-estate-taxes.

[15] See Estate Taxes: Who Pays, How Much, and When, supra note 3.

[16] https://www.cbpp.org/research/ten-facts-you-should-know-about-the-federal-estate-tax#_ftn4

[17] Life Insurance & Disability Insurance Proceeds, available at https://www.irs.gov/faqs/interest-dividends-other-types-of-income/life-insurance-disability-insurance-proceeds#:~:text=Answer%3A,report%20it%20as%20interest%20received.

[18] Id.

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