Planning for Estate Taxes
Once you're worth more than a certain amount, taxes can shrink your estate and thus the legacy you leave behind to your children, grandchildren and friends. In 2013, an individual can exclude $5.25 million from estate taxes. As a result, according to Reuters.com and the Tax Policy Center, "Just 3,800 estates are expected to be big enough to owe any federal estate tax in 2013."
The few people who are subject to this tax can make smart decisions to maximize the amount of their estate they can pass on to the next generation, tax free. Estate taxes are an important subject to understand because even though you may not be wealthy today doesn't mean that you won't be in the future.
In the U.S., an estate tax is imposed when a taxable estate is transferred from a deceased person via a will to an heir. The federal government imposes an estate tax, as does many states (called an inheritance tax). This tax can be leveraged on every U.S. citizen. While the estate tax is mostly imposed on assets left to heirs, it can apply to the transfer of assets to a surviving spouse.
What is the federal estate tax? The federal estate tax is "collected on the transfer of a person's assets to his or her loved ones after death, and the total tax due is calculated by adding up the fair market values of all of the decedent's assets on the date of death and then applying estate tax credits and subtracting out allowable estate tax deductions."
In other words, the federal government taxes the "gross estate," which is the value of all the property interests of a decedent before his/her death. Once the gross estate is determined, the government provides for deductions (funeral expenses, charitable contributions, items of property left to the surviving spouse, etc.). The tentative tax is the sum of the taxable estate and the adjustable taxable gifts. There are credits against the tentative tax which provide exempted value.
Estate taxes are paid by the executor (when estates are larger than the federally exempted amount). There are ways to implement tax avoidance techniques.
Smart Moves that Could Minimize Your Taxable Estate
Whether you own real estate or stocks or whether your primary wealth is due to a business you own, you should speak with an estate planning attorney to plan for estate taxes in the wisest and most responsible manner. You don't want your heirs to be saddled with extreme taxes.
An irrevocable insurance trust could be a smart option for you to explore. This allows your children funds to pay the premiums on life insurance on both you and your spouse. Life insurance proceeds, structured in this way, can be free of estate tax. A charitable remainder trust is also often a viable option. If you own considerable wealth or your own business and are working on estate planning, think through the following wise tips from Reuters.com,
The annual gifting rules allow you to give up to $14,000 per person in 2014(up from $13,000 in 2012) tax-free. These gifts don't count toward the lifetime $5.25 million exclusion, and can add up quickly: A couple with two adult married children, for example, could give $28,000 to each this year, plus $28,000 to each spouse, for a total of $56,000. With education costs high and rising, these funds could seed a 529 college-savings plan for your children or grandchildren.
Ironically, a poor economy can help, because it may depress the value of securities, real estate and businesses, allowing people to get more out of their estates. Wealthy families generally seed trusts with growth stocks or businesses likely to expand; that's because once the asset is transferred, it is out of the estate and its appreciation won't be subject to any future estate tax.
Common Questions About Estate Taxes
We understand that estate taxes are a complicated area of law and that miscalculating your estate could adversely affect your family. As a result, we have compiled answers to some of the most commonly asked questions about estate taxes below:
Do spouses have to pay the tax when they inherit from each other?
There is an unlimited deduction from estate and gift tax that postpones the tax on assets inherited from one spouse until the second spouse dies. This is known as marital deduction and only applies if the inheriting spouse is a U.S. citizen.
How much can the second spouse pass tax-free?
Together, a couple can transfer up to $10.5 million tax-free (known as portability). The surviving spouse must file an estate tax return when the first spouse dies, even if no tax is owed. This return is due nine months after death, with a six month extension possible. If the executor does not do so, he/she loses their chance at portability.
What about lifetime gifts?
The lifetime gift exclusion is currently $5.25 million per person. If you exceed the limit, you or your heirs will owe a tax of up to 40%. You must keep a running tally and report your gifts. As a couple, you can gift-split and give to your children now, tax-free. This means that if you used $1 million of the exclusion to make taxable lifetime gifts, the unused exclusion would be $4.25 million. Keep in mind, however, that this does reduce how much tax-free amount is available when you die.
Are there lifetime gifts that don't count?
Only gifts that exceed the limit count against lifetime exclusion. The easiest way to give to your children or grandchildren is to give cash or other assets each year. You could also put money into a Section 529 education savings plan.
For more answers to your planning for estate taxes questions, consult with an estate planning attorney today or check out the IRS' FAQ on estate taxes. You can also check out our Probate.com estate planning FAQ page for more information that could benefit your estate planning needs.