How To Avoid Estate Tax In US
How to avoid estate tax in US? Read the article below to see some legal strategies to potentially reduce your tax burden.
This article is not formal tax advice is for informational purposes only, and the facts might have changed since we wrote it.
Anybody who wants formal advice should contact a tax professional, or in some cases, the government departments directly.
Many Americans find the concept of the estate tax, or death tax as it is sometimes called, to be frightening. But in reality, the vast majority of people will never come across it.
The reason for this is that the federal estate tax has a very high exemption amount of $12.06 million. Therefore, you won’t owe any federal estate taxes if the value of your estate is less than that exemption for 2022.
However, there are taxes imposed by some states in some areas of the nation that must be dealt with. You might want to consult a financial advisor for assistance with your estate plan.
What Is The Estate Tax?
The total value of a person’s possessions is their estate. There are stocks, retirement accounts, and everything in between.
New York, Washington, and Minnesota are just a few of the states that impose an estate tax in addition to the federal level.
Prior to the estate’s distribution to beneficiaries, estate taxes are deducted from a deceased person’s estate.
The estate tax, also known as a “death tax,” is a tax imposed by the Internal Revenue Service (IRS) on a person’s ability to transfer property upon death.
Inheritance taxes and estate taxes are two different things. They differ significantly in a few significant ways:
- When they are collected. Prior to distributing the estate’s assets to beneficiaries, estate taxes are deducted. After the estate has been divided, a beneficiary’s inheritance is reduced by inheritance taxes.
- Federal and state laws. Only an estate tax is imposed at the federal level. Only a handful of states—including Maryland, Iowa, and Pennsylvania—impose inheritance taxes at the state level.
Currently, there is a $12.06 million exemption from federal estate taxes. This indicates that your estate is exempt from the federal estate tax if the total value of your estate (as determined using fair market value) is less than this sum.
The amount by which your estate surpasses the exemption amount determines the federal estate tax rate, which ranges from 18 to 40%.
The tax rate and the estate tax exemption amount vary depending on the state’s tax laws.
When you leave your possessions to your children, the estate tax is levied against your net worth. The exemption amount is $11.5 million for an individual and $23 million for a couple as of this writing.
These high exemptions, though, are expected to drop to $3.5 million in 2025, or sooner if Congress adopts the law change they are currently debating.
This eventual exemption amount will affect the majority of prosperous business or property owners, making it a genuine threat that requires immediate action.
You ask, “How bad can it be?” After the exemption, the estate tax rate begins at 18%, which is still a sizable portion, but it quickly increases to 40% for anything over $1 million.
The upcoming limit means that your net assets over $4.5 million will be taxed at a 40% federal rate and possibly even more if you reside in a state with its own estate tax.
The good news is that there are strategies for lowering the estate tax now, in the near future, and in the long run (for your kids and grandkids).
These methods range in complexity from straightforward to intricate. Some or all of these might be worthwhile to implement depending on your net worth, earnings, and cash flow.
Just a word of warning. Numerous of these methods lower both your tax obligation and cash flow. It is imperative that you discuss your situation with a qualified, unbiased advisor who can assist you in selecting the best techniques.
How To Avoid Estate Tax In US
As you might anticipate, the idea of having to pay estate taxes after they pass away doesn’t exactly excite the majority of people.
There are several methods you can employ to lessen your debt or completely evade estate taxes. Let us go over several ways how to avoid estate tax in US in the sections below if you think your estate will be liable.
1. Give Gifts To Your Family Members
Giving your family members a portion of your wealth as gifts is one way to avoid the estate tax. Giving to one person in 2022 is tax-free up to $16,000, or up to $32,000 if you’re married and filing jointly.
Up to $12.06 million of your wealth can be distributed as gifts over the course of your lifetime without subjecting you to the gift tax in 2022.
The total number of recipients you can send gifts to in a calendar year is unlimited.
Therefore, if you have an estate worth $18 million, you can distribute your assets to your loved ones over time until your estate’s net value is $12.06 million or less. Just remember that this threshold is combined with the estate tax and applies to both taxes.
2. Make Marital Transfers
When one spouse passes away, marital transfers can help reduce estate taxes. Any amount can be given to your spouse tax-free over their lifetime if they are a citizen of the United States.
A gift tax applies to marital gifts that total more than $164,000 if your spouse is an alien (as of 2022). This tax exemption is only marginally useful, though.
Estate taxes must be paid upon the passing of the surviving spouse on the entire taxable estate, which includes any assets that were previously gifted to the surviving spouse.
To put it another way, marital transfers are advantageous but ultimately just a means of delaying having to pay the estate tax.
3. Gift Money To Minors
Under a few federal laws, people may give tax-free gifts to minors (people under the age of 18) up to the annual gift cap ($16,000 per person in 2022).
Financial assets, such as cash and securities, can be given to beneficiaries who are minors without a formal trust or guardianship thanks to the Uniform Gifts to Minors Act (UGMA).
The UGMA is expanded by the Uniform Transfers to Minors Act (UTMA), which permits gifts of both financial and real property. Real property spans a wide range, from real estate to artwork and intellectual property.
4. Real Estate Valuation
Usually, the value of real estate is determined by its highest and best use. Homeowners who get the most money for their real estate typically benefit from this measure of value.
You can have your real estate valued for its “actual use” as opposed to its highest and best use, though this will reduce the value of your estate for estate tax purposes.
Estate taxes can be significantly reduced by having your real estate valued for its actual use.
5. Set Up A Marital Trust
How to avoid estate tax in US? By establishing a marital trust, you can generally avoid estate taxes as well.
A trust is typically an estate planning document that transfers an individual’s assets to a trustee before distributing those assets to beneficiaries.
When the beneficiary passes away, the trustee is in charge of distributing the trust’s assets in accordance with the terms of the trust. Trusts avoid the probate court process, in contrast to a will.
Marital trusts come in two varieties:
In reality, this kind of trust is a joint trust. The two trusts that make up the “A-B” are referred to as such.
The marital trust created for the benefit of the surviving spouse is Part A. The surviving spouse’s access privileges to the assets are outlined in the trust agreement. For instance, the survivor spouse may live in the home and receive income from the trust.
The assets placed into this trust are exempt from estate taxes. When the surviving spouse passes away and the trust assets are finally distributed to the original spouse’s intended beneficiaries, Part B, a separate trust, comes into play.
This is comparable to an A-B trust, with the exception that the surviving spouse does not have the same level of access to or control over the assets held in the marital trust.
6. Set Up An Irrevocable Life Insurance Trust
It’s a good idea to purchase life insurance if you don’t want to leave your family in a precarious financial situation after your passing. In general, life insurance payouts are not taxable. However, if you pass away, they might be included in your estate and be taxed as such.
You can establish an irrevocable life insurance trust to shield your life insurance payouts from taxes. In essence, you would be creating a trust and handing over ownership to someone else.
Because you wouldn’t be able to change the trust in the future without the beneficiary’s approval, it is irrevocable.
Your death benefits would not be a part of your estate if you transferred over your life insurance policy. But it’s best to do this now rather than later.
The proceeds from your life insurance policy would still be included in your taxable estate if you passed away within three years of making the transfer.
7. Set Up A Grantor Annuity Trust
Grantor Annuity Trusts give you the option to once more undervalue the asset being given to your heirs while also giving you access to current cash flow. Your heirs are the beneficiaries of the trust that you create.
Then, in exchange for payments that will be made over a period of years, you transfer an investment asset into the trust. The asset passes to your heirs at the conclusion of those years.
The gift’s value is determined by deducting the asset’s value from the value of the cash flow you will eventually receive. Discounting is used in this situation.
You retain the cash flow, which lowers the value being provided. It’s a tricky calculation, but let’s say your cash flow is worth 50% of the asset’s value.
8. Incorporate A Family Limited Partnership
You can create a family-limited partnership to transfer any family-owned businesses or assets (such as real estate) to your children after your passing. Typically, a general partnership is formed, and heirs and other family members are then made limited partners.
You will still have full control as the general partner. The difference is that your partners—whether they are your children or another relative—will own stock in your business or a portion of your assets. Your estate will be less substantial as a result.
9. Set Up A Qualified Personal Residence Trust
Funding a qualified personal residence trust is another way to lessen the amount of assets subject to estate tax (QPRT). You give a trust ownership of your house when you use a QPRT.
You can stay in your house for the duration of the trust without having to pay rent. Your property may be inherited by your beneficiaries once that period has expired.
If you haven’t gone over the lifetime exemption for taxable gifts, you can freeze the market value of your primary residence and/or vacation home through a QPRT and evade gift taxes. Additionally, you’ll immediately condense your estate.
Unfortunately, your home will still be a part of your estate if you pass away before the end of the term of your trust. Furthermore, setting up a QPRT for a rental property is simpler than setting up a trust with a mortgage for your home.
10. Set Up Charitable Trusts
How to avoid estate tax in US? Transferring a portion of your wealth via a trust to a charity is another way to avoid estate tax.
There are two varieties of charitable trusts: charitable remainder trusts (CRTs) and charitable lead trusts (CLTs).
In the case of a CLT, a portion of the trust’s assets will be donated to a non-profit organization. By making a charitable donation, you can reduce the size of your estate and receive an additional tax break.
Whatever remains in the trust will be distributed to your beneficiaries after your death (or after a predetermined period of time).
As an alternative, if you have a CRT, you can transfer stocks or other assets that appreciate to an irrevocable trust. You can profit from that possession all through your life.
The proceeds from your investments will then be donated to charity when you pass away. You’ll also lessen your estate tax liability and avoid paying capital gains tax as a result. And you’ll get a tax break.
The beneficiaries of a charitable trust are charitable organizations.
The charitable trust may have a variety of assets, including money, stocks, property, and real estate.
Set Up A Charitable Lead Trust (CLT)
The term “charitable lead trust” (CLT) refers to a trust that is established for a specific time period, frequently the donor’s lifetime, and that provides financial support to a charitable organization during that time.
When the trust is established, the donor is given tax benefits, and the charity receives funding right away. The trust is paid out to designated non-charity beneficiaries when the donor dies or the trust term expires.
Set Up Charitable Remainder Trust (CRT)
Charitable Remainder Trust or CRT is the complete opposite of CLT. This kind of charitable trust appoints the nonprofit organization as trustee rather than paying the charity out of the trust and then transferring the trust to a beneficiary who is not a nonprofit.
Throughout the donor’s lifetime, the organization serves as trustee and disburses funds to the donor or another designated beneficiary. The charitable organization inherits the trust upon the death of the donor.
11. Give Money To Your Kids
How to avoid estate tax in US? Giving money to others is the simplest action to take. Your assets that exceed the exemption amount are subject to the estate tax.
If you own it at the time of your death, your heirs will factor it into your estate’s valuation and deduct the 40% tax from the excess. If you give money to your children or grandchildren before you pass away, that money is not included in your estate and is not taxable.
Gifting is subject to some limitations. You are permitted to give up to $15,000 per person and per recipient in 2021 without incurring any tax obligations.
As a result, mom and dad can give one of their children $30,000 ($15K from dad and $15K from mom). Every year, gifts can be given to each child.
Any additional gifts will lower your estate tax exemption if you make them. If you give one of your children $100,000, you’ve gone over the $15K cap for that year.
You miserably gave away $85,000. That’s okay because the IRS simply subtracts the excess of $85K from the exemption of $3.5 million (using the projected exemption based on current law).
Making generational wealth and leaving a legacy for your heirs is already challenging given the amount of taxes you must pay during your lifetime.
If you do, however, manage to do so, the story is not over yet.
Still, a sizable portion of your beneficiaries’ inheritance will be taken away by estate taxes.
Consult a professional if you feel that is unfair and want to take action using sound tax planning and entirely legal measures.
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Adam is an internationally recognised author on financial matters, with over 529.7 million answers views on Quora.com and a widely sold book on Amazon and a contributor on Forbes.
Donate To A Charity, Gift Money To Minors, Give Gifts To Your Family Members, Give Money To Your Kids, How To Avoid Estate Tax In US, Incorporate A Family Limited Partnership, Make Marital Transfers, Real Estate Valuation, Set Up A Charitable Lead Trust (CLT), Set Up A Grantor Annuity Trust, Set Up A Marital Trust, Set Up A Qualified Personal Residence Trust, Set Up An Irrevocable Life Insurance Trust, Set Up Charitable Remainder Trust (CRT), Set Up Charitable Trusts, What Is The Estate Tax?
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