67% of Americans don’t have any estate plans in place. They don’t have a will or haven’t designated how their assets should be handled.
Without solid estate tax planning in place, your heirs run the risk of paying much higher taxes on your assets.
Are you concerned about how much estate tax your family will have to pay after your death?
Obviously, no one likes to think of their death. However, getting your estate plan in order before you pass away can spare your loved ones needless financial harm.
And while estate planning is strongly encouraged, not many people understand how much estate tax they might owe or how they can minimize the cost.
If you want to learn more about estate tax planning, keep reading below to find out the most effective estate tax planning strategies.
The Impact of Taxes and Estate Planning
When you’re considering estate planning, it’s critical also to consider the tax implications of the decisions that you’re making.
Not only are there several taxes that your estate might be responsible for paying, but these taxes can be quite sizable without some careful planning in place for your heirs.
The IRS has an established threshold of $12.06 million in 2022. Any amount below the established yearly limit will not be subject to taxes. Of course, states also have tax amounts to consider, too.
Another consideration in working with an expert for tax planning is that tax laws constantly change depending on the political climate. Depending on the current tax laws, you may want or need to adjust your tax planning.
What Taxes Might Impact You?
When you do tax planning, you’ll want to consider the several types of taxes that might impact your wealth.
The amount you pay in these taxes will vary based on the amounts in your estate. Yet, you will pay taxes on the assets without some careful planning.
Let’s take a closer look at these assets.
When you die, your assets get transferred to the estate and could be subject to estate tax. This would include assets that include cash, securities, and other property.
This tax, sometimes called the death tax, is paid on the deceased person’s assets. This death tax can run between 18% to 40% depending on the estate’s value. It’s important to note that this tax is based on an asset’s current fair market value.
The federal estate taxes have an exemption limit that allows some lower-value estates from paying estate tax. If your estate exceeds the federal exemption limit, there could be estate taxes that need to be paid.
The good news for married couples is that, generally, assets being inherited by a spouse will be exempt from federal estate taxes. The IRS has an unlimited marital deduction for assets going to a spouse.
Some people will choose to gift some of their assets from their estate before death. The federal government also has something called the gift tax.
If you gift assets without expecting anything back, your gift might be subject to a gift tax if it’s not done carefully.
Again, if your spouse is a US citizen, they would be exempt automatically from any gifts you offer.
Generally, the person gifting money is responsible for the gift tax. Yet, the gift would need to exceed the federal gift-giving limit to be eligible for a gift tax.
The IRS sets those limits by year. In 2022, the annual limit is $16,000, and the lifetime exclusion of $12.06 million in 2022.
If you’re wondering what falls under the category of gifts, it’s cash or the equivalent cash value of something else.
The IRS also has a tax when you gift to a child or grandchild. Generation-skipping transfers or GST come into play when you give money to relatives or grandchildren two or more generations younger than you.
If you also opt to gift money to a non-family member who is at least 37½ years your minor, the GST may be a factor, too.
The IRS will look at any gifts that do a few things.
- Does the gift skip a generation?
- Does the gift exceed the annual exclusion amount for gifting?
If these two factors are in place, you’ll likely need to pay the GST tax.
It might seem unusual for the IRS to place a tax in this scenario. The intention is that you don’t intentionally skip a generation with the goal of your children not paying taxes for the inheritance upon their death.
State taxes are another consideration when you’re doing estate planning. Your estate planning attorney should know the specific laws for taxes in your state.
Many states will have their version of an inheritance tax in addition to the federal taxes you must consider.
Instead of you paying the taxes before your death, many states opt to levy an inheritance tax. This tax needs to be paid by your beneficiary when they are the recipient of your assets.
While the federal government doesn’t consider an inheritance as income, some states consider it this way and tax it accordingly. Sometimes these taxes are even regarded as progressive, which means the rate you pay is higher when the amount is higher.
Some careful estate planning can help to avoid some of these tax liabilities.
Reducing Your Tax Burden
Many people will use estate planning to find ways to help them and their heirs avoid paying many of these taxes. Let’s take a closer look at some of these strategies used in estate planning.
Using Marital Transfers
When you use a wealth transfer where your assets transfer to your spouse, they can delay the need to pay estate taxes.
Taxes can be avoided when lifetime gifts or bequests in a will would not require the spouse to pay taxes when receiving them.
This doesn’t eliminate the potential taxes, but it does delay them. One caveat to this rule is that your spouse must be a US citizen.
Gifting to Children and Grandchildren
The IRS allows you to give annual gifts to children and grandchildren and avoid the gift tax as long as it doesn’t exceed the federal gift tax limit.
If you do this over several years without exceeding the limit, you can significantly reduce your potential tax liability at death.
The idea is to give to your heirs before you die to avoid the tax.
Irrevocable Life Insurance Trust
An irrevocable life insurance trust is also a tax avoidance tool used in estate planning. An irrevocable trust is set up to handle life insurance payments.
You put funds into the irrevocable trust to cover the cost of life insurance premiums. When you die, the life insurance benefits are paid to the trust, not the beneficiary.
The trust can then distribute funds out of the trust, and it’s not necessary to pay taxes on those funds.
There are two gifting strategies used that involve minors. You could use the
- The Uniform Transfers to Minors Act
- The Uniform Gifts to Minors Act
These two acts allow you to transfer assets, including cash, property, or other valuables, to the minor trust. The trust can be managed by the donor or another custodian.
You’re allowed to exceed the federal gifting limit. The good news with this option is that the tax rate is for the minor receiving the gift, not the donor.
They are also only taxed on amounts that exceed the federal limit.
A few kinds of marital trusts are used by married people to avoid paying taxes. These include AB Trusts and QTIP Trusts.
The donor moves money to a marital trust which they can continue to control. Assets moved into this type of trust are not taxed.
The surviving spouse can use assets or interest from the trust while they remain alive.
A QTIP trust is often used when a donor gets married for a second time. The spouse could not access funds from the trust. Although the donor remains in control of the trust while they’re alive.
The assets can go to the children of the donor upon their death.
Family Limited Partnerships
A family limited partnership is often used when a family also has a business interest to consider.
The business can get transferred to a family-owned holding company. The benefits include:
- Minimized income tax
- Continuity of ownership of a business
- Limits liability for family partners
The assets under the partnership remain protected until they’re distributed.
If you have a charitable organization you feel passionate about; you may opt to make a charitable donation at death or create a charitable trust for the charitable organization.
The benefits can be twofold, avoid paying taxes on the donation and even get a tax deduction for your estate based on the donation.
Use Estate Tax Planning to Save Tax Dollars
No matter the size of your assets, it makes sense to consider some estate tax planning for your heirs. It can help them avoid probate and also save on taxes when you die.
If you’re wondering what strategies might work to protect your assets and heirs, we can help. Contact us today to learn more about your estate planning options to avoid taxes.