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How does an estate plan reduce taxes?
Payment of estate taxes can diminish the size of a person's estate, and therefore greatly reduce the value of each beneficiary's gifts. A well-thought out estate plan minimizes estate taxes by reducing the value of the assets that pass-through probate (by will or under intestacy) in order to avoid the assessment of taxes.
Will my estate be subject to federal taxes?
Your estate is subject to federal taxes if it is worth more than a specific amount, which is based on the year of your death (see below). For example, if you die in 2017, then the first $5.49 million (or $10.98 million if you are married) of your estate is exempt from federal death taxes; anything over that amount will be taxed. This exemption amount is referred to as the "unified credit."
If your estate is worth more than $5.49 million, you can avoid or reduce the assessment of taxes by reducing the estate's probate value before your death. This is done through nonprobate transfers - e.g., lifetime gifts, tax-saving trusts, and taking advantage of the unlimited marital tax deduction. It's best to consult an attorney experienced in estate planning to help you in this respect.
Year of Death Exempt Amount
**The amount doubles if you are married**
What is the "unlimited marital tax deduction"?
The unlimited marital tax deduction provides that any property left to your spouse is exempt from federal death taxes as long as she is a U.S. citizen. There is no limit on the amount you can leave to your spouse to avoid the assessment of taxes - you can leave your entire estate. The deduction applies even if your estate is worth more than the tax-exempt amount.
Although it is tempting to leave everything to your spouse to avoid payment of the taxes, it may have only the effect of deferring payment of the taxes if your spouse does not remarry (because she will not be able to take advantage of the deduction on her death). This means she will probably die owning all of the property, and then it is subject to taxes on her death. This is especially of concern if you are both elderly. To find out how to avoid this result, consult a tax attorney who will help you understand other estate planning options.
What is the rate at which my nonexempt property is taxed?
The federal estate tax rate is high. The maximum federal estate tax rate is 40%. This means that nearly one-half of your nonexempt estate will go towards the payment of taxes - a huge loss for your beneficiaries! To avoid this result, and to maximize the amount that your beneficiaries receive on your death, plan ahead. There are many ways to avoid being hit by federal estate taxes:
- Leave property to your spouse - if he is a U.S. citizen the gift will be tax-free.
- Give cash gifts before you die - up to $14,000 (or $28,000 if it is a joint gift with your spouse) per recipient per year is tax-free.
- Make lifetime gifts of your property.
- Set up tax-saving trusts and place your assets in the trusts to shield them from taxes.
- Donate money to an IRS-approved charity - the gift will be tax-free.
How is the federal estate tax computed?
The government will tax any portion of your estate that exceeds the exemption amount, based on its current fair market value.
What property is included in the taxable estate?
The taxable estate includes your probate estate (whatever passes under your will or by intestate succession) plus certain nonprobate transfers, such as the value of any life insurance or 401k plan or property in a revocable trust. Examples of property that may be taxed are the family home, any cars, jewelry, stocks, and bank accounts.
A good estate plan minimizes the effects of taxes. Make the most of the unified credit and the unlimited marital deduction - doing so will preserve the value of the property so it transfers to your beneficiaries instead of to the government.
Will I have to pay death taxes to my state as well?
Most likely, but it depends on the state in which you live. If you live in one of the 18 states or the District of Columbia that levy separate estate and/or inheritance taxes, there’s even more at stake, with death taxes sometimes starting at the first dollar of an estate. New Jersey just repealed its estate tax (for 2018) but left its inheritance tax on the books.
There are three types of death taxes that a state can charge:
- Estate taxes - paid by your estate before it is distributed to the beneficiaries.
- Inheritance taxes - paid by your beneficiaries after they receive the property (there are exemptions for gifts to spouses and other family members).
- Pick-up taxes - comes out of the share you pay under the federal estate tax and is equal to the state death tax credit provided under the federal estate tax.
Will my estate have to pay taxes on gifts that I leave to a charity?
No. The IRS (and most states) provides an exemption from federal estate taxes on charitable gifts made to an approved charity.
TIP: You can find a comprehensive list of charities that qualify for tax-exempt donations, including those eligible to receive tax-deductible charitable contributions, by using the Exempt Organizations Select Check on the IRS Web site: www.irs.gov
Will the recipients of my lifetime gifts have to pay any taxes?
Yes, depending on the state in which you live. A few states impose a gift tax, and the rate will vary depending on state law. The tax is usually limited to property that you give away during a specified time before your death (e.g., 2 years before your death). However, under the "gift tax annual exclusion," the first $14,000 made to any person is tax-free every year. That means that you can give $14,000 to as many people as you like every year and the gift will not be subject to the gift tax. And if you and your spouse make the gift together, the exemption amount is $28,000.
What if I give my daughter $15,000 during my life, and before my death she invests it so it has increased to $20,000. If the first $14,000 is tax-exempt, then does she pay gift tax on the remaining $6,000?
No. That is the beauty of the lifetime gift. The tax is levied only against the value of the property when the gift was made, not against any increase in value. Therefore, when you made the gift, it was $15,000. The first $14,000 is exempt from tax, so she will have to pay gift tax on only $1,000. The $5,000 increase in value is not subject to the gift tax! (Note: She will have to pay income tax on the increase.)
To understand the advantage of making this type of lifetime gift, consider what would happen if you had kept and invested the money yourself. If you took $15,000 and invested it during your life, so that when you died the amount had earned $5,000 in interest, the full $20,000 would be a part of your probate estate and your estate would pay taxes on the full $20,000. The lifetime gift to your daughter protected $19,000 from taxes - the $14,000 that was exempt under the gift tax annual exclusion and the $5,000 increase in value.
Will my estate have to pay income taxes?
Yes, if any of the property in your estate generates any income (usually in the form of interest) before the estate is closed. Some sources subject to income tax include deferred compensation, dividends declared before death, royalties, and proceeds from a sale that was entered into before you died.
What is the future of the federal estate tax?
President Trump has proposed eliminating the federal estate tax entirely, but states are likely to continue taxing estates. In the State of California, for example, legislation is pending to make the estate tax 40%. Thus, even if your estate has a value which is less than the federal estate tax exemption, states that have an estate or inheritance tax may require estate planning to minimize taxes even if your estate is much lower than the federal estate tax exemption.