Death Tax

The death tax is a federal tax on assets that are inherited. 

Estate taxes are due upon the owner’s death. When someone dies, their estate must pay any debts owed by the deceased before passing down assets to inheritors. The total of all assets in an estate is used to calculate the estate tax.

How Does It Work?

All assets, including cash and real property, held by the deceased at the time of death are subject to estate taxes. 

If you inherit an IRA or other retirement account from someone who has died, you’ll have to take distributions over several years that are determined in part by your life expectancy – or pay a stiff penalty in taxes and early withdrawal fees. 

The tax is levied on the fair market value of the assets in an estate, which means that an expensive home or a business can be taxed at a higher rate than lower-valued property. 

In most cases, only the amount over and above an exemption – currently $5 million per individual – is subject to tax at a top rate of 40%.

How Does It Affect Estate Planning?

If you don’t plan for the death tax, you could end up losing a substantial part of your inheritance to taxes. 

You can avoid or minimize the federal estate tax with proper planning. For many families, this means using trusts to reduce or eliminate the tax exposure.

Who Pays the Death Tax?

Most states have a death tax, although these taxes are generally lower than the federal version and typically apply only to larger estates. The Death Tax is paid by those who have been handed down or inherited assets. 

In addition, many states allow residents to credit their state estate tax against their federal estate tax liability. So if your state has an estate tax, but you pay more to the feds, no double taxation will occur.

When Is Death Tax Paid?

Estate taxes are payable immediately upon death. This means that heirs must come up with the cash to pay the tax due on an estate, plus any other debts or expenses owed by the deceased.

Why Should We Care About Death Tax?

With a whopping 40% of any taxable assets being taxed at death, this is essentially double taxation. Given the current economic difficulties, this is a tax that should be eliminated.

For those who are concerned about getting their money to the next generation without being taxed, estate planning with trusts can protect family assets from heirs who may not have earned these funds or paid taxes on them.

However, many people attempt to avoid the Death tax by purchasing life insurance policies on themselves so that their relatives can continue enjoying tax-free growth of their assets upon their death, but this method is often flawed and does not work. 

Who Is Exempted From Paying Death Tax?

The people that are exempted from paying death tax are those that have estates under $5 million. 

Those heirs who inherit the money may still pay tax on the amount above 5 million dollars, but it is at a much lower rate than those with larger estates.

Ways to Avoid Paying Death Tax

There are several ways you can avoid paying death tax.

Irrevocable Life Insurance Trust

This can save your family from paying the high death tax. This is done by putting the insurance policy in the trust, with yourself as the trustee

You are then able to borrow against that policy or even cash it in if needed without having to pay a 10% penalty fee on top of taxes.

Irrevocable Benefit Letter

Where you can also put your life insurance policy in and remove it from your taxable estate. This allows your heirs to use the money without having to pay a penalty or tax on what they receive.

Qualified Personal Residence Trust

You can also place assets into a QPRT and take the rental income from the property instead of selling it and will avoid having to pay tax on those assets as long as they remain in the trust.

Grantor Retained Annuity Trust

This will allow you to remove investments from your taxable estate and receive annuity payments for years without paying any kind of tax. 

Key Takeaways

The death tax is an estate tax that is put on the value of assets in an estate at death. The people exempted from paying this tax are those with estates under $5 million. 

Death taxes should not be taken for granted because they could end up costing you a substantial amount of money. 

To avoid this, creating estate plans with trusts is the best way to protect your assets from being taxed twice, once at death and again when inheriting the assets. There are several types of trusts that can save your family from paying death tax.

Estate taxes are payable upon death. This means that heirs must come up with cash to pay the tax due on an estate plus any other debts or expenses owed by the deceased.
This tax affects individuals who have been handed down or inherited assets such as stocks, mutual funds, and real estate that are valued at $1 million or more.
The higher your total assets, the higher your tax rate will be. If you die with less than $5 million in assets but more than $10,000 you might pay a flat 40% tax rate on the amount of money that exceeds $10,000.
If you don't plan for the death tax, you could end up losing a substantial part of your inheritance to taxes.
If you have assets in your estate that are valued at a million or more, then you may be taxed twice on the same assets.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.