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Ultra-wealthy Should Plan for 40% Estate Tax

Updated: Feb 17, 2023

The federal estate tax exemption is going up again for 2021. The amount is adjusted each year for inflation, so that's not a surprise. But it's still a big deal when the new exemption is announced each year because there's a lot at stake for certain wealthy Americans.

Government takes a cut of your estate.
The federal government could be owed a portion of your estate. It's up to your planning to decide how much of a cut.

2021 Estate Tax Exemption

Generally, when you die, your estate is not subject to the federal estate tax if the value of your estate is less than the exemption amount. For people who pass away in 2021, the exemption amount will be $11.7 million (it's $11.58 million for 2020). For a married couple, that comes to a combined exemption of $23.4 million.

Estate Tax Rate

As you might guess, only a small percentage of Americans die with an estate worth more than $11.7 million. But for estates that exceed that amount, the federal tax bill is pretty steep. The estate’s value beyond $11.7 million could be taxed at a 40% rate.

The first $1 million is taxed at lower rates – from 18% to 39%. That results in a total tax of $345,800 on the first $1 million, which is $54,200 less than what the tax would be if the entire estate were taxed at the top rate. However, once you get past the first $1 million, everything else is taxed at the 40% rate. If a single person’s estate who passed in 2021 was worth $13.7 million, the estate would owe $745k in federal taxes.

Since the federal estate tax was reformed in 1976, the estate tax exemption has increased through acts of congress. In most cases, the increase is modest, such as a simple adjustment for inflation. However, at times, the exemption amount has jumped considerably. For example, it shot up from $675,000 to $1 million in 2002, from $1 million to $5 million in 2011, and from $5.49 million to $11.18 million in 2018.

But that pattern is scheduled to change. The 2018 increase is temporary, so the base exemption amount is set to drop back down to $5 million (adjusted for inflation) in 2026. Moreover, the federal estate tax exemption could drop back down sooner. Legislation currently being proposed could reduce an individual’s exemption to $5 million in 2022.

State Estate Taxes

Just because your estate isn't hit with the federal estate tax, that doesn't necessarily mean you're completely off the hook. Your estate might be subject to a state estate tax. Twelve states and the District of Columbia impose their own estate tax, and the state exemption amounts are often much lower than the federal estate tax exemption. For instance, the exemption amount in Massachusetts and Oregon is only $1 million.

Plus, six states levy an inheritance tax, which is paid directly by your heirs. (Maryland has both an estate tax and an inheritance tax!) So, just because your estate isn't worth millions of dollars, you children and grandchildren might end up with less in their pockets when you die than what you're expecting.

What You Can Do

Have a conversation with your financial advisor and your estate planning attorney. You may want to review your estate plan and forecast whether your heirs will owe a federal or state estate tax or inheritance tax. Once you have an idea of the amount, you can examine strategies to either reduce the value of your estate or set aside cash or insurance policies to fund the bill for heirs. If most of your assets are illiquid – such as farmland or real estate – you may need to think creatively about how your heirs will create liquid cash to pay the IRS. A life insurance strategy is one consideration. Or, a sale of inflated assets prior to death could make sense at today’s lower capital gains rates.

Final thought.

Is your estate plan up to date? Do you have a plan for heirs to cover both federal and state estate taxes? If you have a net worth over $2 million and need help from a wealth manager, the Peak Wealth Planning team can assist you.

Peak Wealth Planning specializes in helping high-net worth individuals and families plan for the future.

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About the Author

Peter Newman is a Chartered Financial Advisor (CFA) and president of Peak Wealth Planning. He works with individuals nationwide that have accumulated wealth through company stock, ESOP shares, real estate, or running a business. Peter applies his unique background to help clients achieve their specific goals and enjoy peace of mind.

Peak Wealth Planning provides concierge services to meet your wealth management needs. Services include: financial planning, investment management, esop diversification, retirement income, insurance, and estate planning advice. Peak Wealth Planning is a fee-based financial advisor based in Champaign, Illinois, and Fraser, Colorado.


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