Estate Taxes

Estate Taxes (often called the 'death tax' in political debates) are a tax on the transfer of a person's assets to their heirs after they pass away. Think of it as a final tax bill settled by your estate—the total collection of everything you own—before your loved ones receive their inheritance. The tax is calculated on the estate's net value after certain deductions are made. While the concept can sound alarming, the reality is that for the vast majority of people in the US and many parts of Europe, estate taxes are a non-issue. This is because governments set a very high value threshold, known as an exemption, and only estates worth more than this amount are subject to the tax. For instance, the US federal government allows estates worth many millions of dollars to pass to heirs tax-free. The tax is primarily designed to apply to the transfer of significant generational wealth.

The process, while managed by professionals like accountants and lawyers, follows a logical path. Understanding the steps can demystify the entire concept and empower you to plan more effectively.

Calculating the potential estate tax involves a few key steps:

1. 1. Calculate the Gross Estate: This is the starting point. It involves adding up the fair market value of everything the deceased person owned or had an interest in at the time of death. This includes cash, stocks, bonds, real estate, business interests, art, and even the death benefit from life insurance policies owned by the decedent.
2. 2. Subtract Allowable Deductions: The gross estate is then reduced by subtracting certain expenses and bequests. Common deductions include mortgages and other debts, estate administration expenses, funeral costs, and charitable contributions. A significant deduction in the US is the unlimited marital deduction, which allows an individual to transfer an unlimited amount of assets to their surviving spouse tax-free.
3. 3. Determine the Taxable Estate: What's left after subtracting deductions is the taxable estate.
4. 4. Apply the Tax: The estate tax is calculated on this final taxable amount. However, a large credit is applied that effectively exempts a significant portion of the estate from any tax.

The key to the whole system is the estate tax exemption (also known as the unified credit). This is the dollar amount that the government allows you to pass on without triggering the tax. For example, the US federal estate tax exemption in 2024 is over $13 million per person. This means an individual could leave an estate worth up to that amount and owe zero federal estate tax. Because of a concept called portability, a married couple can effectively combine their exemptions. If the first spouse to die doesn't use their full exemption, the surviving spouse can add the unused portion to their own, potentially allowing the couple to pass on over $26 million tax-free. It's crucial to remember two things:

• These numbers change. Political administrations often adjust the exemption amount, so what's true today might not be true in a decade.
• State vs. Federal. While the federal exemption is high, about a dozen US states levy their own estate tax, often with much lower exemption thresholds. This is a critical detail for residents of those states.

As a value investor, your goal is to patiently build wealth through smart, long-term decisions. Preserving that wealth for the next generation is the final chapter of a successful investment story. That's where estate planning comes in.

Even if your net worth is currently far below the exemption threshold, it's never too early to have a plan. The power of compounding over 20, 30, or 40 years can turn a modest portfolio into a very substantial one—potentially large enough to be affected by future estate taxes. Effective estate planning isn't about avoiding taxes at all costs; it's about control. It ensures your assets are distributed according to your wishes, smoothly and efficiently, minimizing potential tax burdens and legal fees. It is the ultimate expression of securing long-term value for your family.

For those with estates likely to exceed the exemption, several legal strategies can help manage the potential tax liability. These are complex and require professional advice, but it's helpful to be familiar with the concepts:

• Gifting: You can systematically reduce the future size of your estate by giving away assets while you're alive. In the US, the annual gift tax exclusion allows you to give a certain amount (e.g., $18,000 in 2024) to as many individuals as you like each year, tax-free and without eating into your lifetime exemption.
• Trusts: Trusts are powerful tools for moving assets out of your taxable estate. For example, an Irrevocable Life Insurance Trust (ILIT) can own a life insurance policy, so the death benefit is paid to your heirs without being included in your estate. Other instruments, like a Grantor Retained Annuity Trust (GRAT), are designed for transferring appreciating assets with minimal tax impact.
• Charitable Giving: Donating to qualified charities, either during your lifetime or through your will, can reduce the size of your taxable estate.

People often use the terms “estate tax” and “inheritance tax” interchangeably, but they are different.

• Estate Tax: Paid by the estate of the deceased before any assets are distributed. This is the system used by the US federal government.
• Inheritance Tax: Paid by the heir who receives the property. Only a handful of US states use this system. The tax rate often depends on the heir's relationship to the deceased; a child typically pays a much lower rate than a distant cousin or non-relative.