Whether your estate is liable for federal estate taxes depends on several factors: the value of your gross estate, the amount of debt you owe at the time of your death, the total expenses incurred while settling your estate, and any deductions that your estate is eligible to take.
The process of calculating what your estate is likely to owe—if anything—might seem complicated at first glance, but it's really just a matter of doing some elementary math.
Determine the Value of Your Net Estate
The starting point for determining your estate tax liability is the value of your gross estate. This is the total value of everything you own at the time of your death. You'll then subtract certain transactions from that gross total to arrive at the value of your net estate for estate tax purposes.
Debts and Expenses
Deductible debts include mortgages, lines of credit, personal loans, and credit card debt that you owe at the time of your death. You can also include funeral expenses and medical bills as administrative expenses to settle your estate or revocable living trust because these are costs that your estate will have to pay for. Other administrative expenses include attorney fees, accounting and appraisal fees, storage and shipping fees, insurance, and court fees.
You can't know what your administrative expenses will be yet, but you can arrive at a rough estimate by multiplying your gross estate by 5%.
Subtract the overall total of these debts and expenses from the value of your gross estate.
Charitable transfers include direct gifts and property set aside in a charitable remainder trust or a charitable lead trust. Most individual estate plans do not have these considerations.
Subtract this total from what's left of the value of your gross estate after deducting your debts and estate expenses.
Transfers to a Spouse Who Is a U.S. Citizen
Include outright transfers by right of survivorship and transfers made to a trust that qualifies for the unlimited marital deduction, such as the "A trust" that's established when you're using AB trust planning or ABC trust planning.
Deduct this total from the remainder of your gross estate after subtracting your debts, expenses, and charitable transfers. This is your net estate.
Determine Your Federal Estate Tax Liability
Now you can subtract your available federal estate tax exemption from the value of your net estate to arrive at your taxable estate.
The federal estate tax exemption for 2017 was $5.49 million, then it jumped to $11.18 million in 2018 under the terms of the Tax Cuts and Jobs Act (TCJA). The exemption is indexed for inflation, so it tends to increase incrementally from year to year. It's $12.06 million in 2022, up from $11.7 million in 2021.
Your estate tax exemption will be reduced if you made any taxable gifts during your lifetime that exceeded the annual exclusion from gift taxes, $15,000 in 2021, increasing to $16,000 in 2022, and if you did not pay the gift tax on those transfers at the time. It will be equal to the difference between the total exemption available less the value of your lifetime gifts that exceeded the annual exclusions.
Example: Death in 2022, No Lifetime Gifts
Let's say you die in 2022 and your gross estate is worth $8 million. Your allowable debts, expenses, and other deductions were $500,000, so your net estate was $7.5 million.
You would then subtract your available estate tax exemption from your net estate value to arrive at your taxable estate. The calculation would work out like this if you didn't make any taxable gifts during your lifetime that exceeded the annual exemption amounts:
$7,500,000 net estate less $12,060,000 estate tax exemption equals ($4,560,000) taxable estate
Your estate tax exemption is $4.56 million more than the value of your estate, so no tax is due.
Example: Death in 2017, No Lifetime Gifts
Now let's use the same numbers, but assume you died in 2017 when the estate tax exemption was much less. Your gross estate was still $8 million and your allowable debts, expenses, and deductions were still $500,000. Your net estate was $7.5 million.
Again, you would subtract your available estate tax exemption from your net estate to arrive at your taxable estate. Your estate would owe a tax of $804,000 if you didn't make any taxable gifts during your lifetime that exceeded the annual exemption amounts:
$7,500,000 net estate less $5,490,000 estate tax exemption equals $2,010,000 taxable estate
Your taxable estate is then multiplied by the 40% tax rate to arrive at your federal estate tax liability, which in this example equals $804,000.
Example: Death in 2017, $4 Million in Lifetime Gifts
Now let's use the same numbers in the first example but assume that you made $4 million in taxable gifts during your lifetime over and above the annual exemptions that were available to you at the time. The $4 million in taxable lifetime gifts must be subtracted from your available estate tax exemption. This leaves you with a $8.06 million exemption instead of $12.06 million.
$7,500,000 net estate less $8,060,000 estate tax exemption equals $560,000 taxable estate
Applying the same 40% estate tax rate to your taxable estate, your estate would owe a tax of $224,000.
It's unlikely that most people will have to concern themselves with these scenarios from 2018 through 2022 due to the significant increase in exemptions under the TCJA. But the TCJA is set to sunset or expire at the end of 2025 unless Congress takes steps to renew it, so it's possible that the estate tax exemption could plummet back to the $5 to $6 million range at that time.