YOU CAN LEAVE any amount to a spouse who is a U.S. citizen without worrying about federal estate taxes, thanks to the unlimited marital deduction. But if you bequeath a total of more than $11.58 million to other folks in 2020 or $11.7 million in 2021, federal estate taxes kick in at a 40% rate. This $11 million-plus threshold is sometimes referred to as the unified credit—though this isn’t strictly correct, because the credit is the tax you avoid, not the sum that avoids taxation.
Don’t have anything close to $11 million? Taxes could still take a bite out of your estate for two reasons. First, your estate could be taxed at the state level. A third of states levy either an estate tax or an inheritance tax, and sometimes both. Second, if you bequeath retirement accounts, other than Roth accounts, your heirs will owe income taxes as they draw down those accounts. The embedded income tax bill on traditional retirement accounts affects far more Americans than federal and state estate taxes, but it doesn’t garner nearly as much attention.
What if you leave your heirs your home, which is worth far more than you paid? What if you bequeath regular taxable accounts where you hold, say, stocks with large unrealized capital gains? For those investments and for your home, there’s good news: These assets enjoy a step-up in cost basis, which means their purchase price for tax purposes becomes the price as of your death. Result: Unlike with a retirement account, the embedded tax bill disappears. You may want to factor this into your planning as you consider which accounts to spend down during your lifetime and which to bequeath.
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