Many people who meet with an estate planning attorney for the first time ask about the estate tax. While much of estate planning law flies under the radar of political commentators or the news media, there is always a lot of coverage whenever politicians propose a change in the estate tax.
Since 2005, Colorado has had no estate tax and no inheritance tax. However, the federal estate tax can affect some families. If the conditions are right, even some families that don’t think of themselves as wealthy can find that a loved one’s estate is subject to the tax.
To understand why, first we should briefly discuss the ideas behind the estate taxes. When a person passes away, all their assets and remaining debts become known as their estate. If their “gross” estate is above a certain level, a federal tax kicks in. For tax purposes, the person’s gross estate consists of all assets in which the deceased had an interest at the time of their death. This can include real estate, jointly owned property and other types of assets that may still be in use by other people. For instance, if the deceased co-owned a house with a spouse in joint tenancy, the deceased person’s gross estate includes half the value of the house, and is therefore potentially subject to an estate tax.
There are important deductions and exemptions that can affect how the estate tax applies in any particular case. One of the most important is the marital deduction, which allows an entire estate to pass tax-free to the deceased person’s surviving spouse. Another is the personal exemption, in which a certain amount of the estate can avoid the estate tax.
Congress can, and frequently does, change the personal exemption amount from year to year. It currently stands at $11.58 million for an individual. For a married couple, the exemption is $23.16 million. In other words, a deceased person can leave $11.58 million to their heirs without any of it being subject to the federal estate tax. However, if the estate is worth $12.58 million, then it is $1 million over the limit. Therefore, $1 million of the estate is subject to the tax.
The exemption amount is so high now that it is only an issue for the largest estates. However, with the cost of real estate rising rapidly in many markets, even some families that don’t think of themselves as wealthy can find that a loved one’s estate goes over the limit. Estate planning attorneys use a variety of strategies to manage the size of their clients’ eventual estates so that they can avoid the federal estate tax.