The federal estate tax applies to asset transfers when someone passes away and leaves assets to beneficiaries. The tax rate starts at an attention-getting 40 percent.
That’s the bad news. The good news is that an exclusion allows you to transfer an amount tax-free. The portion of an estate that exceeds the exclusion is what would be subject to taxation.
There are annual estate tax adjustments to account for inflation, and we are going to share the 2021 number in this post. But before we get there, we will take a look at recent history to provide context.
The estate tax parameters have changed dramatically over the last 20 years. In 2001, the exclusion was just $675,000, and the rate was an eye-popping 55 percent. It went up to $1 million and the maximum rate was reduced to 50 percent the following year. The exclusion climbed to $3.5 million and the rate was reduced to 45 percent in 2009.
These changes occur when “tax reform” legislation is passed, and typically remain in place for a prescribed period of time before they “sunset” or expire. A provision in the Bush era tax cuts resulted in a complete repeal in 2010.
This piece of legislation was to sunset at the end of 2010 and the $1 million/50 percent arrangement from 2002 would have returned.
At the end of 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (H.R. 4853) was enacted. It set the estate tax exclusion at $5 million with a 35 percent top rate for 2011.
The American Taxpayer Relief Act was enacted in 2012. This retained the $5 million exclusion adjusted for inflation, and increased the rate to 40 percent.
These changes held sway for five years, until December 2017 when the Tax Cuts and Jobs Act that was enacted, raising the exclusion all the way to $11.18 million for 2018 while retaining the 40 percent rate.
The exclusion has been adjusted for inflation each year, with the exclusion slated to be $11.7 million for 2021.
This law will sunset at the end of 2025, so if no new law is enacted between now and then, the 2026 exclusion will go back down to $5.49 million in 2017.
Federal Gift Tax
One way people tried to avoid estate tax was through lifetime gifts. People did this for a few years after the estate tax was originally enacted in 1916, but then a gift tax was put into place in 1924 to close the loophole. This gift tax was repealed in 1926 and the window of opportunity was open for another six years before the gift tax was reenacted in 1932. It has been in place since that time, and it was unified with the federal estate tax during the decade of the 1970s.
Since these taxes are unified under the tax code, the 2021 $11.7 million exclusion applies to both lifetime gifts and the estate transferred after your passing.
In addition to this multi-million dollar exclusion, there is a separate annual gift tax exclusion. You can give away up to $15,000 per year to any number of people, totaling any amount of money, tax free.
There is also an educational exclusion that allows you to pay school tuition for others without incurring any gift tax liability. And there is a medical exemption. You are not taxed if you pay medical bills for others, and this includes health insurance premiums.
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