As our estate and trust attorneys can confirm, many of the clients who consult with us after experiencing the loss of a loved one must confront the only other major certainty in life: taxes. Fortunately, the actual impact of “death taxes” is often less of an issue than our clients anticipate. Here are a few types of taxes that arise with the administration of estates and trusts.
Inheritance Taxes. Maryland has a fairly unique tax referred to as an “inheritance tax.” Only six states in the United States impose this tax, and the rules are a bit different in each of those states. In Maryland, inheritance taxes of 10% are imposed on most bequests to individuals who are not a lineal descendant or spouse of a lineal descendant, parents, siblings, grandparents, or stepchild of the decedent. Although most individuals ultimately devise their assets to individuals who are exempt from this tax, it often negatively impacts individuals who wish to devise assets to a niece, nephew, or close friend. Bequests to 501(c)(3) charitable organizations or organizations that are eligible for deductible transfers under Section 2055 of the Internal Revenue Code are also exempt from inheritance tax.
Estate Taxes. Although estate taxes get a lot of press, they are not imposed on every estate – or even most estates! For individuals who pass away with over $11.4 million of assets (as of 2019), their heirs can expect to pay a federal estate tax of approximately 40% on assets that are above that threshold. In addition, Maryland is one of several states that imposes its own estate tax: Maryland residents who pass away owning more than $5 million of assets will have a Maryland estate tax of approximately 16% on the assets above the $5 million threshold. Generally, though, gifts to a spouse or charitable organization are exempt from estate taxes, and there are a number of planning opportunities available to individuals who are concerned their estate will be subject to estate taxes. With both federal and Maryland estate taxes, married couples have an additional advantage; with a little planning, a total of $22.8 million at the federal level, and $10 million at the state level can be protected from estate taxes upon the deaths of both spouses.
Generation-Skipping Transfer Taxes. Closely related to estate taxes are taxes referred to as a “generation skipping transfer tax” (or “GST tax”). The GST tax is a type of tax that is imposed on transfers made to grandchildren or much younger beneficiaries. This tax was established to prevent people from transferring large amounts of assets to grandchildren, because those people were trying to avoid federal estate taxes at two different generations (i.e. at both the deaths of the parent and later their child, by “skipping” over the child). However, as with estate taxes, each individual has an $11.4 million exemption from federal GST taxes, and a $5 million exemption from Maryland GST taxes. Frequently, this is a concern for higher net-worth individuals who, for one reason or another, wish to “skip” over an adult child and bequeath assets to grandchildren.
Income Taxes. Upon the passing of an individual, the obligation to pay income taxes does not necessarily end. For example, the beneficiaries of traditional IRAs will need to pay income taxes as they make withdrawals. On the other hand, the death of an owner of an appreciated asset really helps that deceased owner’s beneficiaries because any unrealized capital gains get “zeroed out” as of the date of death; this often means that significant capital gains taxes can be avoided upon the sale of the appreciated asset that was inherited by the beneficiaries. Finally, as a practical matter, estates and trusts are also responsible for paying income taxes on income earned by assets held in an estate or trust. Under federal tax law, the income tax brackets for estates and trusts are substantially more compressed than those for individuals: while an individual would need to earn over $510,300 per year to incur the highest federal income tax rate of 37%, an estate or trust would only need to earn over $12,750 to reach the 37% income tax rate. In many cases, though, if income is distributed from the trust or estate to the individual beneficiaries of that trust or estate, it is possible to allocate the income tax burden to the beneficiaries, who are usually in a lower income tax rate, so the high-income tax rates on estates and trusts are not always of major concern.
As you can see, although the various “death taxes” can be a serious issue for some estates and trusts, they are not necessarily the biggest concern for individuals who wish to set up an estate plan. This can give a lot of peace of mind for individuals who are in the middle of working on their estate planning, and allow those individuals to focus on the parts of legacy planning that are most important to them.
For questions about this article or any other Estate Planning matter, please contact an attorney in our Estate Planning group.