How Taxes Can Affect Your Estate Plan
One of the most intimidating parts of estate planning is determining the potential impact of estate taxes and how you can avoid or minimize them whenever possible. Unfortunately, the way things are set up, the likelihood that you avoid estate taxes entirely is very small, but you still have a good chance of minimizing them if you plan correctly.
After all, estate taxes can wreak havoc on your years of planning and send your heirs into a frenzy trying to protect your assets and their inheritance.
Put everyone at ease by understanding exactly what estate taxes you may be facing and how you can structure your estate to make the most of available exemptions.
Gift Tax Giving
property as gifts while you’re still alive is a popular probate-avoidance technique, but it’s not without risks or consequences. If you don’t plan appropriately and you have a large estate, you may be hit with a gift tax.
Anytime you give one person more than $14,000 in a year, the balance over that initial $14,000 will be considered taxable and incur a gift tax.
But, here’s where it pays to know your tax exemption rules.
The federal tax code gives you a lifetime gift tax exemption worth $5,430,000 in 2015, and adjusted annually for inflation. So, what that means for you is – though you have an annual cap on what you can give to one individual without being taxed ($14,000), you can take exemptions on the taxable amounts over that, which comes out of your lifetime exemption of $5,430,000.
Though, it’s important to remember that’s a LIFETIME exemption, it’s the same one that’s applied to your estate when you die, so whatever balance you’ve accrued while living lessens the exemption on your estate when you pass.
Federal & State Estate Taxes
As mentioned above, there are both federal and state estate taxes as well as some exemptions, like the federal estate tax exemption of $5,430,000. The remainder of your estate after credits and deductions, if over $5,430,000, can be taxed at a maximum rate of 40%
Luckily for most of the United States, only a handful of states have a separate estate tax. Those states include; Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Tennessee, Vermont, Washington, and the District of Columbia.
Beyond a tax on your estate, some states also collect taxes from certain beneficiaries as well, this is called a separate inheritance tax.
The distinction between estate taxes and inheritance taxes may seem slight, but it’s really not. The determining factor is who’s being taxed. Estate taxes are assessed on the decedent’s estate. An inheritance tax is assessed on a beneficiary’s inheritance.
The states with inheritance tax for certain beneficiaries are; Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
The good news is, even in those states assets passing to a surviving spouse are exempt from the inheritance tax. And, Iowa, Kentucky, Maryland, & New Jersey also exempt assets transferring to descendants as well.
Generation Skipping Taxes
Anytime you gift or transfer assets to a relative who is more than one generation younger than you, like your grandkids, or an unrelated person who is more than 37.5 years younger than you, you’ll incur a generation-skipping tax. Even assets distributed through a trust can be subject to this particular tax as it’s the government’s way of making sure every level (generation) pays taxes on the inheritance.
While it’s no fun being taxed “no matter what”, there is a silver lining. Each person more than two generations below you who is inheriting (referred to as a skip-person) is allowed an estate tax credit/exemption worth $2,000,000.
Because of this fairly large exemption, most people don’t actually have to pay the generation-skipping tax at all, which is good news because it tops out at 40%!
Just thinking about all the taxes that can affect your estate is enough to give anyone a headache.
Take heart, most of us will not owe any estate tax because of the high exemption amounts. The breakdown of those who owe actually works out to be less than 1% of total estates. And, those of us who do end up paying estate taxes usually only pay about 1/6th of the estate’s value in taxes (that’s TOTAL assessed taxes).
Though the maximum estate tax rates are high (around 40%) the exemptions are also high, so only the amount in excess of the exemption is taxed. It also helps that the effective tax rate – which is what’s actually assessed – is much lower than the max rate and usually falls around 17%.
Still worried about how estate taxes could impact your estate plan?
If you need additional help or guidance making sense of all the tax codes and exemptions, don’t hesitate to contact an estate attorney in your area.
It’s especially important to discuss your situation with a professional; at least initially, so you can understand not only what taxes may affect your estate, but also get up-to-date information on state and federal taxes, which can change annually.