The federal estate tax targets people that have been particularly successful from a financial standpoint. There is a relatively high exclusion, and you don’t have to pay the tax if the value of your estate does not reach this threshold.
To understand the place we are at right now, you have to absorb a bit of a back story.
Path to the Current Exclusion
In 2009, the federal estate tax exclusion was $3.5 million, and the maximum rate was 45 percent. There was a complete repeal in 2010 that was embedded in the Bush era tax cuts, but this legislation was scheduled to sunset at the end of that year.
If there had been no changes to the existing laws, the exclusion would have gone down to $1 million in 2011. This did not happen because the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (H.R. 4853) was passed.
It allowed for a $5 million exclusion in 2011 and a 35 percent top rate. This rate remained in place with an inflation adjustment the following year.
The American Taxpayer Relief Act of 2012 kept the inflation-adjusted $5 million exclusion in place, but it raised the rate of the tax to 40 percent. There may have been “relief” for some taxpayers, but an increase in the rate of the estate tax does not fit that description.
This arrangement remained in place until the Tax Cuts and Jobs Act went into effect in 2018. A provision contained within this measure essentially doubled the exclusion to $11.18 million.
There have been inflation adjustment since then, and the 2021 adjustment will bring the exclusion up to $11.7 million.
Important Details for Married Couples
There are a few things you should know about the federal estate tax aside from the exclusion and the rate.
The tax bill that was passed in 2011 made the estate tax exclusion portable. This means that a surviving spouse can apply two exclusions to their estate. Portability has been included in all of the tax acts that have been passed since then.
There is an unlimited marital estate tax deduction. You can transfer any amount of property to your spouse free of taxation, as long as your spouse is an American citizen.
Federal Gift Tax
You can’t give out inheritances in advance while you are living to avoid the estate tax, because there is a federal gift tax that is unified with the estate tax. Your available exclusion would be reduced by the value of tax-free gifts that you give during your life, but there is a caveat to this statement.
In addition to the unified gift and estate tax exclusion, there is also a separate gift tax exemption. It allows you to give up to $15,000 to an unlimited number of gift recipients during a calendar year free of taxation.
Connecticut State Estate Tax
Connecticut is one of 12 states that have state-level estate taxes, and our exclusion is going up next year as well. It has been $5.1 million in 2020, and in 2021, it will be $7.1 million.
There is just one state that has a gift tax, and that state is Connecticut. The $15,000 annual exemption that exists on the federal level also applies to the Connecticut gift tax.
If you give a gift of more than $15,000 to any one person during a calendar year, you would be using a portion of your larger exclusion.
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