4 "Death" Tax rules in 10 minutes you should know

Did you know there is no such actual thing as a "Death" tax? The term was used by some in the 1940's to raise some outrage over the estate tax system. But there are some tax rules that are related to death which you need to know. Let's go over 4 "Death" tax rules in 10 minutes!

May 16, 2023

Transcript

16th 2023. I hope your spring is off to a great start. I figured I'd just join you with my coffee out in the morning. Just take advantage of some vitamin D before I'm in the office for the rest of the day. So I hope you don't mind with the sunglasses, otherwise I get a little squinty, which inevitably leads to that sort of headache, during the course of the morning.

So, why don't we talk to you about something specific today? So this question comes up for me, multiple. Multiple times a week and it's, Hey, Neel, tell me about death taxes, some version or another of death taxes. And I guess, you know, I know what people mean now at this point, this is what, 23 years of me practicing law ish.

So you get a feel for what people mean after a while, even though they're not using the vernacular. But here's the thing, there's no such thing as actual quote unquote death. Taxes, death, taxes. It actually started back in the forties because there was some opposition to these taxes that will be paid upon death.

And they figured, Hey, if we start calling them death taxes, then then maybe, maybe we can get some opposition to it. People will be vehemently opposed. But the estate tax. Which is what most people think about when they think about the estate, about the death taxes itself. This has actually been around for a long time.

I think the highest rate ever was right after World War ii, if I'm not mistaken, was close to like 70, 75% or something like that. It was pretty large. In fact, Teddy Roosevelt is famous for saying, you know what, it's not good for any generation. To pass wealth down from one generation to the next. We want each generation to rise on its own merits.

So, kind of giving you a little bit of a history lesson, without giving you too many specifics, but let's remember the way America was founded, if you will. At least by its current regime is a bunch of people got on ships and they wanted to escape this aristocracy. And, because it, they, they didn't want this sort of ruling class.

They wanted to make sure that, that each generation passed down from one or the other. So at least that's a story that I've heard of it, and I honestly think it, it makes sense, even if you're not happy with the way it's implemented, but here's more relevant for you. Four things that you need to know about, quote unquote death taxes.

And it's not just the estate tax, and I'm gonna throw in one bonus one here as well too. So the first estate tax, death tax that you need to know is just that. It's the estate tax. So this is when the government looks at, okay, what is it that somebody's passing away with if it. Is more than the threshold, the exemption, we're gonna charge a tax, and that tax right now is 40%, but the exemption, the threshold is pretty high relative to what it's been in the past.

It is 12.9 million in 2023. So what that means is somebody could die with 12.9 million and there would be no estate tax if it exceeds 12.9 million and it's going to anybody other than a US citizen spouse. Then we're gonna take a 40% estate tax. Okay. Now there i, I am grossly summarizing here. It's early coffee hasn't kicked in yet right now, so at least you get the concept here.

So that is how the estate tax works. Now for spouses, it's a little different. If I give to a, a citizen spouse and, and, and they basically get, there's an unlimited amount, I could give a trillion dollars theoretically. To my US citizen spouse, and she would not pay an estate tax if she received a hundred percent of my money.

It's an unlimited marital deduction that can get passed down. Now, here's the thing you need to know about this. It seems really high. Neel, why are you even sharing this with me? Well, it is high, but two things that you should know about that is one. In 2025, at the end of 2025, the existing tax law is scheduled to sunset.

And what that means is we get in our time machine and we go back to 2017, and that's the tax law that's going to be in effect. And that tax law basically is gonna be, let's just say it's about 6 million or so. It's, I think five and a half million adjusted for inflation. So the estate tax that you're allowed to die with, so the exemption amount that you're allowed to die with is gonna go down to about 6 million.

And again, anything over that gets taxed at 40%. Same thing applies with respect to spouses. Now, the government got smart about this, and they said, okay, Neel, if we wait until you die to get this 40%. What you're gonna do when you get older is just start giving your stuff away. And if you start giving your stuff away, we're not gonna get our 40%, we being the government.

So here's what we're gonna do. We're not just gonna let you give as much as you want away during your lifetime. In fact, whether you give it away during your lifetime or whether you die with it, you're still only limited to 12.9 million right now. So I give away, theoretically $3 million. Right now, during my lifetime, I'm only allowed to die, only allowed to die with 9.9 million.

And when the exemption goes down, I've already used up 3 million. So if it goes down to let's just say 6 million, then I gave away three. I had six that I was allowed to, so I'm only allowed to die with another 3 million or so. So I know the numbers get kind of hairy, but just keep in mind. You can't give it all away during your lifetime.

There's a limit on that, and you can't die with an unlimited amount. There's a limit on that, and that limit's scheduled to change in 2027. So that's the first one, and that's also the bonus one, you're estate tax and your gift tax. You could broadly refer to those as wealth transfer taxes. Now, some states like New Jersey, like Pennsylvania, have something different called an inheritance tax.

The estate tax in my example, was levied upon me and my estate when I died. The inheritance tax is more about who receives the money. So the inheritance tax is going to be the, basically the recipient. And now in New Jersey for example, it's only gonna be the, anybody who's not a Class A beneficiary.

So what that really means is not a lineal descendant. I won't spend too much time, cause I know we have viewers and listeners all over the country, so I'm not gonna spend a lot of time talking about New Jersey specifically. But just to give you an example, in a contrast, Pennsylvania. Has an inheritance tax.

It doesn't matter whether you're a lineal descendant, I mean anybody other than a spouse really, but you could have any children who will pay some component of an inheritance tax pass. So you got a state tax slash gift tax, now you have inheritance tax. Those are sort of what have broadly been referred to as death taxes.

There's a couple of sneaky ones that you should know about as well too. The one is the with with respect to IRAs. 401ks and your pre-tax dollars. So under the Secure Act of 2019, IRAs are also not basically, well, let's just say sometimes there's a tax impact to those two. Anybody other than a spouse receiving an ira.

If I pass away with an IRA of say, $500,000 or a 401k of $500,000 and. I am not leaving it to a spouse, I'm leaving it to anybody other than a spouse and maybe a charity. And there's a few other exceptions here. That recipient, that beneficiary is at best case, gonna be forced to take everything out within 10 years, and therefore it means they're paying all the taxes within four years.

I'm gonna squint a little bit so you could see some eyes and you could tell that I'm keeping eye contact with you. So the interesting thing about IRAs and 401ks is like, okay, you've got somebody who's older. Pro, presumably in a lower tax bracket. And now you have your kids or grandkids inheriting these IRAs, okay, back down these IRAs.

And they're gonna have to pay all the taxes within 10 years of on that money. And again, if they're in a higher tax bracket, they might be paying more. So that's not a death, sorry, an estate tax per se, but it is something that's by virtue of death. So that's one of the sneaky ones. A little more complex, super important, but especially if you have a lot of qualified money.

Which a lot of folks who have worked all their lives may have. And the last one that I wanna talk about, it's not really a, it's probably the more complex one, but it is something that you need to be mindful of. It's this concept of the step up in cost basis. And just know that if I bought a property where for a hundred thousand dollars back in 1970, and today that condo in, or that that house in Brooklyn that I bought for a hundred thousand dollars is worth $3 million.

Well, when I die, assuming that I'm holding it the way that I held it all my life, and assuming that it's not in been given away, that new cost basis for my family is going to be the fair market value at the time that I die. So what does that mean? That means that when I die, that $3 million fair market value is now my beneficiaries.

My kids knew cost basis, so they could sell it for 3.1 million and they only pay taxes on the difference between the 3 million and the 3.1 million at a hundred thousand versus. If I give it to them during my lifetime, then basically their cost basis is the same as mine. It's still that a hundred thousand that I paid back in.

In 1970. So it's really important to know what the cost basis is of your assets before you actually gift them to somebody, because it could have a pretty dramatic capital cans impact. And that's also the case if you move it into an irrevocable trust. And I'm not, and I know I mentioned a property here, but that's the same situation if you're dealing with stocks, for example, or artwork or you know, some sort of other, really any other asset for the most part.

So that step up rule is pretty important now. I am generalizing. It's early. Like I said, we're just having coffee. It's, it's Shah Plan-it. It's, it's meant to be a sort of snippet of information. Not legal advice, not tax advice, not financial advice. But all that being said, you should know that there are also special rules that apply.

So, for example, if I am giving something to a spouse, I mentioned there's an unlimited marital deduction. That's an important rule to know. With the IRA rules, some of it's a little more beneficial. Like if I basically gave it to a, if a disabled child was getting it, then you might be able to do the stretch.

Or if there's spouses and there's a certain age gap, there might be a stretch there too. So you wanna make sure that you know what some of the exceptions are. But there's a lot of misconceptions, a lot of sort of, false information out there about what an estate tax or a death tax or a wealth transfer tax is.

Hopefully the, this, demystifies a little bit. Now I am committed to Shah Plan-it and I'm gonna be here for you every Tuesday when I can. I actually missed the last Tuesday, but I'm gonna be here ev every Tuesday that I can. But I do wanna know what's important to you. So I'll ask a couple of favors.

If there's any topics that you wanna make sure we cover during s Shah Plan-it, please reach out to us. Let us know what it is you'd like for us to speak about. And if you haven't already liked us on Facebook or subscribe to us on YouTube or Spotify, please do. And tell a friend if you think that we're,  the information that we're sharing is helpful because I, I do believe that, we can spread a lot of great information and we can defeat ignorance.

Well, Neel Shah from Shah Plan-it, I hope you'll enjoy your day, your week, your spring, and I'm looking forward to seeing you next week. Stay safe.