Estate taxes are a fact of life. Maybe someday legislatures will do away with such taxes, but for now, they do have to be considered.
First off, the estate tax is a federal tax for sure, and your individual state may also have an additional estate tax or death tax.
Worse yet, at the federal level and, as far as we know, at the state level for all states that have a death tax, this tax is not charged because of what you own at death. It’s about what you had power to direct at your death. In other words, the taxable state includes not only the property and equity you have, but also the payout value of insurances and other accounts, and anyone else’s money or assets that you had power to direct to other people. This last example is called “power of appointment,” and it can catch people napping if they’re not aware of it.
In the end, the estate tax is actually, then, a “transfer tax,” since it taxes value you have power to transfer from one place (usually your own estate) to another. There are two other types of “transfer tax”: The gift tax and the generation-skipping tax. The gift tax is similar to the estate tax in many ways, but deals with value transferred while you still live. The generation skipping tax is an additional tax to the estate or gift taxes, and applies to money or value that you transfer to anyone beyond your first generation of normal heirs or recipients, for example, your grandkids.
There was a time when the estate and generation skipping taxes had rates of over 50% and, added together, could tax a gift or bequest to grandchildren into oblivion.
Keep in mind that this tax applies to money you’ve already paid income tax on. The only rescue here comes from the “lifetime exclusion amount” (“LEA”). As of this writing, it stands at about $14 million in total countable, estate-taxable assets and powers, so a couple could conceivably lawfully shelter almost $28 million before any estate tax would be owed. For those above that level, though, more intricate structuring is called for in order to avoid paying taxes that didn’t have to be owed.
Current federal estate tax rates range from 18% to 40%, arranged in brackets just like the federal income tax. You’ll hit that top marginal rate at only $1 million in your taxable estate, so the lower estate tax brackets are deceptive. It has historically gotten as high as 77% (1941), and is always subject to whichever political party is in power at any given time.
It always pays to verify whether or not you need to consider transfer tax planning for your estate. Even if you’re not subject to such taxation now because your estate value is below the lifetime exclusion amount, the tax laws can change on a dime because you never know what Congress and state legislatures are going to do when power changes hands.
Just be aware of this punishing additional tax that most people never consider when planning their estate or lifetime gifts.