Understanding Federal Estate Tax Exemptions
When planning your estate, understanding federal estate taxes is an essential step. These taxes can affect how much of your wealth is passed to your heirs and which planning strategies you may need. While many people will never owe federal estate tax, those with larger estates must be aware of the rules, exemptions, and planning opportunities. Being informed can help you make decisions that protect your assets and ensure your wishes are carried out.
What Federal Estate Tax Is
The federal estate tax is a tax on the transfer of property after someone dies. It applies to the total value of a person’s estate, including real estate, investments, business interests, and personal property. The goal of the tax is to generate revenue from large transfers of wealth. Only estates above a certain value threshold are subject to federal estate tax. Estates below this threshold are exempt and do not owe taxes.
How Exemptions Work
Federal estate tax exemptions allow a certain amount of property to pass to heirs without being taxed. For 2025, the exemption is $13.61 million per individual. This means an estate valued below this amount will not owe federal estate tax. Married couples can combine their exemptions, potentially shielding up to $27.22 million. These amounts are adjusted annually for inflation and may change based on future legislation.
The exemption works by subtracting the exempted amount from the total value of the estate. If the remaining value exceeds the exemption, only that portion is taxed. Estates below the threshold do not need to pay federal estate tax, although they may still need to file a return in certain situations.
Unified Credit and Lifetime Gifts
Federal estate tax planning also considers lifetime gifts. The Internal Revenue Service allows individuals to make tax-free gifts up to the exemption amount during their lifetime. This is part of the unified credit system, which combines gift and estate tax rules. For example, if someone gives $5 million in taxable gifts during their life, the estate exemption is reduced by that amount at death. This system allows individuals to transfer wealth gradually and reduce the size of their taxable estate.
It is important to track lifetime gifts carefully, as reporting requirements exist for gifts over $17,000 per recipient per year in 2025. Proper record-keeping ensures that the exemption calculations are accurate and avoids potential penalties.
Portability for Married Couples
Married couples in New York can take advantage of a feature known as portability. This allows the unused exemption of a deceased spouse to be transferred to the surviving spouse. For example, if one spouse passes away and uses only $5 million of their $13.61 million exemption, the remaining $8.61 million can be added to the surviving spouse’s exemption. This effectively increases the estate tax-free amount for the surviving spouse, reducing potential tax liability.
To claim portability, an estate tax return must be filed for the deceased spouse, even if the estate is below the exemption threshold. This step is crucial for ensuring the surviving spouse receives the additional exemption.
What Property Is Included in an Estate
Federal estate tax applies to the total value of an individual’s assets at the time of death. This includes real estate, bank accounts, retirement accounts, stocks, bonds, business interests, and valuable personal property like art, jewelry, or vehicles. Certain transfers, such as gifts made during life, may also be included depending on the circumstances. Understanding which assets are counted helps individuals plan strategically to minimize estate tax exposure.
Some assets, like life insurance policies where the deceased had ownership, are included in the estate. Others, like jointly owned property with rights of survivorship or certain retirement accounts, may have special rules. Consulting a knowledgeable estate planning professional can clarify which assets are subject to estate tax.
Strategies to Reduce Estate Tax Liability
There are several legal strategies to reduce estate tax liability for estates near or above the exemption threshold. One approach is making lifetime gifts to heirs or charitable organizations. Another is using trusts to remove assets from the taxable estate. For example, irrevocable life insurance trusts allow individuals to transfer life insurance proceeds outside of the estate, reducing potential tax exposure.
Charitable giving is also an effective tool. Donations to qualified charities during life or at death can reduce the taxable value of the estate while supporting causes you care about. Additionally, certain business succession planning strategies can help preserve family businesses and minimize estate taxes.
Filing an Estate Tax Return
Even if no tax is owed, estates exceeding the exemption threshold must file a federal estate tax return, known as Form 706. Filing provides the IRS with necessary documentation and ensures that any unused exemptions, portability claims, or lifetime gifts are properly recorded. Missing deadlines or filing incomplete information can lead to penalties and affect the surviving spouse’s ability to use portability.
The estate tax return must generally be filed within nine months of the decedent’s death. Extensions are available, but timely filing is important for accurate reporting and compliance.
Interaction with State Estate Taxes
While New York does not impose a separate estate tax for smaller estates, it does have its own state estate tax with its own exemption threshold. Planning for federal estate taxes should consider how state taxes might affect the overall estate. Coordinating federal and state planning can prevent unexpected tax liabilities and maximize the amount passed to heirs.
The Importance of Professional Guidance
Federal estate tax rules are complex and can change over time. Working with an estate planning attorney or tax professional helps ensure your plan takes advantage of exemptions, portability, and other strategies. Professionals can also assist in drafting trusts, wills, and other documents that protect your assets and reflect your wishes.
Estate planning is not just for the wealthy. Understanding exemptions and planning ahead allows you to make informed decisions, reduce taxes, and provide for your loved ones in a way that aligns with your goals.
Conclusion
Federal estate tax exemptions provide a valuable tool for individuals planning their estates in New York. By understanding the exemption amounts, portability rules, and how lifetime gifts interact with estate taxes, you can take steps to minimize tax liability and preserve wealth for heirs. Combining careful planning, professional guidance, and regular review of your estate plan ensures that your assets are protected and your wishes are honored. Taking the time to address these matters today can prevent complications and provide peace of mind for the future.