Don’t Let Taxes Eat Up Your Estate

Benjamin Franklin once said, “in this world, nothing is certain but death and taxes.” You may spend a lifetime paying taxes each year, but did you know that your estate can still be taxed after you pass on?

In this article, we aim to outline the types of taxes an estate faces once a person passes away, how much they could owe, and ways to mitigate or avoid these taxes through proper estate planning.

What Is an Estate Tax?

Often referred to as a “death tax” due to when it kicks in, an estate tax aims to tax a deceased person’s estate before the assets are disseminated to beneficiaries, or heirs. There is a federal estate tax that affects everyone, and some states have their own separate state estate tax on top of the federal tax. State estate taxes have varying rates and apply in only the following states: Connecticut, Illinois, Maine, Massachusetts, Maryland, Minnesota, New York, Oregon, Rhode Island, Washington D.C., and Vermont.

Courts will calculate your “gross estate,” meaning the market value of property including cash, real estate, investments and trusts, and other assets. After this, deductions will be applied based on mortgages and other debts. While this may sound like a lot, the good news for most folks is that the federal estate tax requires a very high value before it kicks in.

If you’re wondering if an estate tax is something you have to be worried about, this article will be helpful. However, it is always best to consult with an estate attorney who can discuss the specifics of your estate and determine whether there will be any taxes based on your estate plan.

How Can an Estate Tax Be Minimized?

First and foremost, the estate tax at the federal level only kicks in for estates valued higher than $12,060,000 if the owner dies in 2022. If the gross estate is valued at less than that amount, the estate tax won’t apply.

Additionally, it’s important to note that an estate is only taxed for every dollar of value above $12,060,000. For example, if a person’s estate is valued at $17 million, then the deceased is only liable for taxes on $4,940,000. Anything under $12,060,000 will not be taxed, much like how the income tax works. If the estate belongs to a couple, any value over $24,120,000 will be taxed. While not yet relevant, it’s also important to note that starting in 2026, the estate tax will be reduced down to $5,000,000 for an individual. This means that after 2026, estates of the deceased will be taxed for any value above that amount, unless the law is changed again.

However, if your estate value is greater than $12,060,000, there are still ways you can minimize how much tax you have to pay. One way is to set up an irrevocable life insurance trust. While proceeds from life insurance aren’t typically taxed, a policy will become part of the policyholder’s estate when they pass away, subjecting it to the estate tax. However, with an irrevocable life insurance trust, the policy is handed off to a predetermined trustee once the policyholder passes away, meaning it won’t be calculated as part of the estate.

Additionally, if the deceased is a business owner who intends to have the business run by their family, they can set up something called a family limited partnership. For example, let’s say Pat owns a shoe store and wants to make sure her kids will continue the family business after she’s gone. Pat creates a partnership for her business and makes her heirs limited partners. While alive, Pat still has control, but once Pat passes away, her partners (in this case, her kids) will own a stake in the company. The stakes that belong to the kids will not be factored into the gross value of Pat’s estate.

Can Philanthropy Help Avoid Estate Taxes?

Yes it can! Giving gifts not only makes all involved feel good, but it’s a terrific way to avoid paying estate taxes. Anyone can give a maximum of $16,000 a year to any individual tax-free, and individuals are limited to a lifetime gift amount of $5,340,000. However, gifting is not always the most efficient way to avoid an estate tax.

Charitable donations can also help individuals avoid estate taxes. It is possible to create a special type of trust, called a charitable remainder trust (CRT), which will allow the deceased to dictate how their money is sent to charities of their choice after they die. A CRT is irrevocable, meaning that after you die, no one but a designated trustee can make changes to the trust. Once the creator passes away, the income from the trust will go to the charities of choice, thus minimizing the value of the estate and even earning additional tax deductions in other areas.

Deciding on which of the above options can be a complicated and daunting task. While it is possible to plan your estate without any help, it is always recommended that one consult an estate attorney. An estate attorney will be able to analyze each situation, ask pertinent questions, and advise on the best strategy to minimize the value of an estate to avoid estate taxes.

What Is an Inheritance Tax?

An inheritance tax is a type of state tax levied by only certain states, including Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. There is no federal inheritance tax. While an estate tax targets the deceased, an inheritance tax targets the beneficiaries of the estate. So, when it comes to the inheritance tax, the recipient of the estate will be taxed based on their specific share.

An inheritance tax is based on the relationship the beneficiaries had with the deceased. Generally, the closer the relationship, the lower the tax rate. In some states, surviving spouses and children are fully exempt from any inheritance taxes.

For example, Donna wishes to leave a $300,000 inheritance to her husband, her son, and her sister, split equally among the three. Under New Jersey inheritance tax rules, when Donna passes away, her son and husband will not need to pay any inheritance taxes on their $100,000 shares. However, her sister will need to pay sizable inheritance taxes on her $100,000 share. As with most instances, the taxes to Donna’s sister can be minimized through proper planning.

Is it Possible to Minimize an Inheritance Tax?

Of course! And many of the same strategies we used for the estate tax will apply to the inheritance tax. In most states that have an inheritance tax, immediate family members don’t have to worry about a high tax rate. However, once beneficiaries exceed close family, the taxes can become hefty.

Just like with the estate tax, getting an irrevocable life insurance plan will assure the deceased’s life insurance proceeds are not part of their estate when they pass away. For family businesses, setting up a limited partnership also serves the same estate preservation purposes as it does for the estate tax. Additionally, donating to charities via a CRT, or giving gifts is a more meticulous, but philanthropic solution to exerting control over your estate.

Obviously, the best way to avoid both the estate and inheritance tax is to move to a state that doesn’t have them, but moving states is not typically a quick or easy solution. In fact, it might not be possible at all. So if you live in an inheritance tax state, the best option is to consult an estate attorney who will be able to help navigate the complicated process of avoiding as much posthumous taxation as possible.

Why Hire an Attorney?

It’s always difficult to contemplate one’s possible future incapacity and how to manage assets, estates, and affairs before it happens. But planning for this situation ahead of time is much more favorable than dealing with the consequences of having no plan when it’s already too late to make one. It can be especially burdensome if paying estate and/or inheritance taxes are necessary.

At Rosenblum Law, we’ll work with you to create a plan that covers all of your bases and leaves your family prepared to take on any situation and manage your affairs in the way you wish. Call us today to get started with a free consultation with one of our experienced estate planning attorneys.

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