Finances and taxes are only one component of what we help donors think about when it comes to leaving a legacy. But we tend to get a lot of questions about estates and taxes: how heirs may be impacted by taxes, and how strategic gifts to charity and loved ones can help mitigate a tax burden.

“I don’t need tax planning. My estate isn’t taxable!” one client told us recently. 

He meant well. He was financially savvy–and had been frugal his entire life–but didn’t quite get the ins and outs of all the ways estates can be taxed, and how someone’s state of residence can impact that. 

As nonprofit leaders, you likely know that there’s a gigantic generational transfer of wealth coming in the next few decades in America. We’ve found that estate taxes–both understanding how they work and avoiding unnecessary tax–are a huge motivator for people and families as they determine how to incorporate strategic charitable giving into their estate plans.

The question “is an estate taxable?” is a little more complex than it seems. So, for individuals and nonprofit leaders alike, we decided to share all the info someone needs to answer that question and start making more informed decisions about legacy planning and charitable giving. 

First, a quick note: We recently wrote a whole post about calculating someone’s net worth or estate value. If you–or a donor at your nonprofit–need a little help with that, here’s how! Take a few minutes to tally up estate assets and liabilities–as well as the major events that could change those numbers down the road. That’s step one.

Step two, then, is understanding whether an estate is taxable on the whole, and also whether there are assets that will incur tax when they transfer to others someday. Those tend to be the best places to start when determining how and when someone can make significant charitable gifts–or incorporate tools that strategically time gifts to heirs. 

Let’s get started.

Is an estate taxable?

The first thing that comes to mind to most people when we mention taxes and estates is the Estate Tax–sometimes called the “Death Tax.” For 2023, the federal Estate Tax threshold is $12,920,000 per person–or $25,840,000 for a married couple–meaning assets over that amount are taxed at death, before estate distributions are made to beneficiaries, if someone dies in 2023. We won’t get into the weeds on what this means for surviving spouses, or exemptions, but you can find out more about estate tax, and how the threshold has changed in recent years, on the IRS website. In short, many estates are NOT taxable at the federal level.

Here’s where it gets a little more complicated. In addition to the federal Estate Tax, some states also have a tax that occurs on the transfer of estate assets before they’re distributed to beneficiaries (Estate Tax)–or on the assets that are being inherited (Inheritance Tax)–and sometimes both. In Minnesota, assets over $3M per person are taxable at death. Iowa taxes an inheritance, with a maximum of 10% tax. Maryland has an estate tax on assets over $5 Million and an inheritance tax up to 10%. 

Confused yet? AARP has a handy map of states that have these taxes in place, but you’ll want to look up your state’s tax code to understand the specifics–it can have a huge impact on someone’s tax liability. If you’re doing fundraising or leading a nonprofit, the state in which you work will impact how you talk to donors about their strategic giving opportunities.

Are estate assets taxable?

Let’s assume an estate is not “taxable” as defined above. Still, any assets that the government hasn’t taxed yet will be taxable to a person/family (as they utilize those assets during life)–or to their heirs (if they inherit assets someday). This is not estate or inheritance tax, but income tax we’re talking about here.

In general, assets that are funded pre-tax–often through an employer or direct paycheck withholdings–fall in this category. We sometimes call these “qualified assets,” and they’re taxable as income, so the tax rate varies based on someone’s economic position:

• Traditional IRA
• 403B
• 401K
• Pension
• Some annuities
• Government-provided military benefits

What estate assets are not taxable?

Put simply, post-tax assets go tax-free to heirs at someone’s death. This includes:

• Roth IRA
• Mutual funds
• Health Savings Account (HSA)
• Cash, checking, and savings accounts
• Stocks and bonds
• Vehicles, jewelry, antiques, home furnishings, and other belongings 
• Irrevocable life insurance trust (ILIT) assets
• Life insurance
• Business ownership

What about things that are funded post-tax, but have significant appreciation?

One important thing to note is that the current federal tax code allows for heirs to inherit real estate, stocks, and securities with a “step-up” in basis. What does this mean? Let’s say George owns a piece of hunting land that he bought for $50,000 in 1972, but now the land–and the small cabin he later built himself with $50,000 in materials–are worth $270,000. If George sells the property, he will pay Capital Gains tax on the “gain” he’s realized: the difference between the fair market value and his cash basis ($270,000-$100,000=$170,000). Depending on his income and the location of the property, a hefty percentage of the sale price could go to taxes! Check out Smart Asset for a handy calculator that approximates Capital Gains tax.

If George puts that property into his will or trust, and gives it to his heirs, they are not liable for that tax.  

Pro tip: Pay attention to legislative changes–or opt in to our blog updates–so you don’t miss changes to this important provision. Many have hinted at this law changing down the road, which could impact many families’ legacy plans and finances! It also may mean a huge opportunity for nonprofits, because gifting to charity–or funding a donor-advised fund (DAF) that’s earmarked for longer-term giving–from a real estate asset is an incredible way to eliminate tax.

Can someone decrease the tax on their estate?

Yes! Pre-tax assets–“qualified assets”–are often what people want to decrease or eliminate from their estate. One of the most impactful things we do at Apex is help people eliminate unnecessary tax from their estate so they can maximize what they’re able to do long-term for their loved ones and favorite causes:

• We run illustrations on different legacy scenarios that incorporate tax-efficient charitable and investment tools, like donor-advised funds, non-cash gifts, and charitable trusts, to name just a few. 
• We model the payments, over time, that could be made to the person/couple, their beneficiaries, and charitable organizations through each scenario. 
• We project market growth and estimate the potential tax that each option could incur.

Often, families can significantly decrease their tax liability–or their heirs’ income tax liability–through strategic gifts to heirs or charity. These can be made during life or through testamentary vehicles in their estate. This is where the magic happens!

Nonprofits, you have a huge opportunity to provide education on strategic giving tactics and tools. People give generously from their estate assets when they understand the tax benefits of doing so–and when they’re assured that they still have enough for their own retirement needs and to support their heirs. 

This information is not intended to serve as financial or legal advice. And there’s no one-size-fits-all approach to legacy planning! We encourage you to seek wise financial and legal counsel before making any legacy-related decisions. If you need a referral, we’re happy to provide one!