What are Inheritance and Estate Taxes
Inheritance taxes are paid by the individual heirs who receive inherited property. While there is no Federal inheritance tax, some states treat inheritance as income and will tax the recipient of an inheritance.
The decedent’s estate pays estate taxes before the estate assets are distributed to the heirs.
Florida Inheritance and Estate Taxes
Under Florida law, the estates of Florida residents are not subject to inheritance or estate taxes. As a state with no income taxes on individuals, the taxable estate at the state and local level in Florida will be zero. That is the good news. The challenge is that large estates will still be subject to federal estate taxes, and effective estate planning is necessary to avoid the decedent’s estate taxation by the federal government.
The elimination of the estate tax means that, for decedents dying on or after January 1, 2005, there is no longer a state death tax imposed on top of the federal estate tax by the State of Florida. This is good news for Floridians because it makes it easier for families to transfer wealth between generations without worrying about paying an additional state death tax. However, there are still some essential things to keep in mind.
Even though there is no longer a state death tax imposed in Florida, the personal representative of an estate may still need to complete certain forms to remove the automatic Florida estate tax lien. The reason for this is that when the Federal government enacted the repeal of the federal estate tax credit for state death taxes paid, they did not include a provision explicitly repealing the automatic lien that arises upon a person’s death in Florida. That means that even though there is no longer a state death tax owed, the personal representative of an estate will still need to take action to remove the lien from the property. Anytime a person dies, their estate is subject to extensive probate proceedings. In Florida, if the decedent’s estate is required to file Internal Revenue Service (IRS) Form 706 or Form 706-NA (Federal Estate Tax Return), the personal representative may also need to file the Affidavit of No Florida Estate Tax Due (Florida Form DR-312). This Affidavit is necessary to release the Florida estate tax lien. The Affidavit must be filed within three years of the date of death, and the personal representative under oath must sign it. If the personal representative fails to file this Affidavit, they may be penalized. As such, it is essential for anyone serving as a personal representative to be aware of this requirement.
There is also an exception if the estate includes property in another state. In that case, the inheritance tax will be based on the tax rate in the state where the property is located. For instance, if the deceased person were a Florida resident but owned real estate on the New Jersey shore, that property would be subject to estate and inheritance taxes in New Jersey. This can be a significant issue for Florida residents who split time between high-tax jurisdictions, such as New York or New Jersey and Florida. The assets that are in the high-tax jurisdiction will be subject to state-level taxation by those jurisdictions based on the value of the property within that jurisdiction.
It is a good idea for individuals who have complex estates to get competent legal advice and coordinate with their financial advisor to minimize the taxes on the decedent’s estate – especially if the gross estate includes real property or significant personal property in northern states with high state income tax, or if the decedent has property outside the United States.
Federal Estate Tax Law
Regardless of the location of the assets, however, the estate will be subject to federal estate tax. Much can be done to mitigate the tax liability for Federal estate tax – but that needs to be completed before death.
What is the federal estate tax, and who has to pay it?
The federal estate tax is a tax that is levied on the value of a person’s estate after they die. The tax is assessed on the gross estate’s value, less debt and expenses. The estate tax rate ranges from 18% to 40%, depending on the estate’s value. Only estates worth more than $5.49 million are subject to the tax. Estates worth less than this amount are exempt from the tax. The executor of the estate pays the federal estate tax. If there is no executor, the person who inherits the estate is responsible for paying the tax.
How is the estate tax calculated, and what are some of the exemptions that apply?
The estate tax is a tax imposed on property transfer at death. The tax is calculated based on the gross estate value, less debts, and expenses. The tax rate is progressive, meaning that it increases as the value of the estate increases. Several exemptions apply to the estate tax, including the exclusion for gifts made during life and the exclusion for property left to a spouse or charitable organization. In addition, there is a Federal estate tax exemption for the first $5 million of the estate’s value. Because of this sizable exemption amount, only a tiny portion of estates are subject to the estate tax. For those subject to the tax, it can be a significant financial burden.
What are some ways to reduce or avoid the estate tax altogether?
There are several ways to reduce or avoid the estate tax altogether. One common strategy is to give gifts during your lifetime. The IRS allows each taxpayer to give up to $16,000 annually to unlimited recipients without triggering the taxable gift tax in 2022, necessitating filing a gift tax return. This amount will increase to $17,000 for the tax year 2023. These amounts, however, count against your lifetime gifts exemption and need to be tracked. For 2022, the lifetime gift tax exemption is $12.06 million per individual. This means a married couple could give away $24.12 million over their lifetime, subject to the annual individual taxable gifts limitation. However, the current tax law will begin to shrink this exemption over the 2020s to $6 million per individual. While this can change, it is essential to stay on top of tax law changes and plan for the worst case, given current economic and deficit levels.
Another way to reduce your exposure to estate tax is to invest in a life insurance policy. Because the death benefit is typically exempt from taxation, life insurance policies can effectively transfer wealth to your heirs without tax liability. With careful planning, it is possible to minimize your exposure to estate tax and ensure that your loved ones inherit as much of your hard-earned wealth as possible.
Federal Income Tax
While the Florida state constitution currently prohibits a state level income tax, that does not extend to federal taxation – particularly for inherited retirement accounts. Unless you are a surviving spouse, you must take distributions on inherited retirement accounts over ten years. Roth accounts are not subject to income taxes. Inherited property transferred to beneficiaries after death may be subject to capital gains taxes. While these taxes can add up, they are often offset by the fact that the value of the property generally receives a “step-up” in basis at death, which can minimize or eliminate any capital gains tax liability.
When a person dies, their assets are typically inherited by their spouse or children. However, the process can be more complicated if the deceased is not a U.S. citizen. To inherit from someone who is not a citizen, the heir must first obtain a foreign inheritance certificate from the country where the deceased was a citizen. They will then need to petition the U.S. Citizenship and Immigration Services to establish their relationship with the deceased. Once the petition is approved, the heir can apply for a U.S. visa to receive their inheritance. While the process may be daunting, it is possible to inherit from someone who is not a U.S. citizen. With proper planning and preparation, heirs can ensure that they receive their rightful inheritance.
Resources
A few good resources can help you if you are looking at estate and financial planning in Florida. The best is an excellent combination of an accountant, lawyer, and financial planner to form an estate planning “dream team,” I cannot stress the need to have the right professionals working together to make your plan work correctly. A few books that I recommend are:
The Florida Residency & Estate Planning Guide – this book gives the Florida basics, including tips on how to limit your out-of-state exposure if you are moving or exposed to high-tax jurisdictions.
Basic Operations: Estate Planning for Business Owners – with more self-employed people than ever, almost everyone is a small business owner or works with one. This information will help structure your business and estate to protect your business and help preserve value.
Savvy Estate Planning – This is a “read before you talk to a lawyer” book and will give you the right questions, issues to raise, and how to find the right attorney.