10 Ways to Reduce or Avoid Estate Taxes
For over 100 years, the United States Federal Government has taxed a person’s assets that remain after they pass away. However, the current estate planning laws give individual’s an exemption limit that allows them to pass a portion of their assets down to their heirs tax-free. Currently, the federal estate tax exemption for an individual is $11,580,000 and $23,160,000 for married couples. While this exemption will increase with inflation until 2025 if Congress does not renew this bill, the estate tax exemption limit will fall to around $3,500,000 per individual.
As no one can predict what Congress will do in a few years let alone when they will pass away, it is crucial to begin estate planning now to avoid federal estate taxes.
To calculate how much estate taxes you will owe, you must first add up the total value of your estate and then subtract your debt. The value of your estate includes all your assets and not just cash or money invested in stocks or retirement accounts.
10 Ways to Avoid or Minimize the Federal Estate Tax
Currently, any assets you transfer upon your death that go past the estate tax exemption will be taxed at an 18 percent rate for the first $999,999 and a 40 percent rate for anything over $1,000,000. Thus, utilizing one or all the ten estate planning tactics could save you millions of dollars.
Buy Life Insurance Now and Use the Benefit to Pay the Tax
Purchasing life insurance is not something you can do when you are nearing the end of your life. Instead, the earlier you purchase this insurance, the better as you can secure a death benefit amount to cover the majority of any estate taxes you may have to pay. Though this estate planning strategy does not help you avoid estate taxes, it makes paying the tax easier for your family.
Move to a State without Estate Taxes
Currently, 17 states and the District of Columbia have an additional estate or inheritance taxes. Thus, establishing residency in a different state can benefit your estate tax situation in more than one way. For example, moving to a different state after retirement not only helps you save on property and income tax. However, it can also minimize your state estate and inheritance taxes. One important note is that if you own homes in multiple states, your residency may be in question. In this case, it is important to speak with an attorney to ensure you establish residency.
Gift Assets While you are Alive
One of the easiest ways to minimize your estate tax liability is to spend or transfer some of your assets while you are still alive. Those with taxable assets can accomplish this goal through:
- Spending assets outright. The fewer assets available in your estate upon death, the less the tax liabilities for your estate and your executor.
- Gifting assets to family members or charities. You are permitted to gift up to $15,000 per donor and per recipient tax-free each year (not including charities). In addition, if you accelerate any charitable gifting, you can take advantage of the itemized deduction today while also reducing your taxable estate in the future.
Set up an Irrevocable Life Insurance Trust
A life insurance trust consists of three parts. The grantor, the person who funds the account and is insured by the life insurance policy. The beneficiary, the person who will receive the life insurance payout once the grantor passes away. Finally, the trustee is the person who will oversee, manage, and distribute the assets within the trust. Once the insurance policy is in the trust, the trustee will pay the premiums each month. Furthermore, when the insured individual passes away, the trustee will collect the payout, pay for funeral expenses, and distribute the funds to the beneficiaries of the trust according to the terms of the account.
For most trusts, the grantor of the trust can also be the trustee to the trust. However, in order to receive the tax benefits of this trust, the grantor cannot be the trustee of the trust. Thus, most people either choose their spouse, oldest child, or a corporate entity as their life insurance trustee. In many cases, people choose the corporate entity—such as a bank or trust company—because these entities have experience with the responsibilities that come with being a trustee.
Set up a Charitable Trust
A Charitable Remainder Trust—also known as a “CRT”—is an irrevocable trust created under the authority of Internal Revenue Code § 664 (“Code”). A Charitable Remainder Trust is a trust that lets you donate to charity while giving you and your heirs big tax savings in the process. Typically, one will fund a CRT with highly appreciated long-term assets. These assets include real estate or stocks that create an income stream for the beneficiaries with a remainder of the trust’s assets donated to one or more charities.
One of the major benefits of a CRT is the potential for the grantor to take an immediate charitable deduction against the income produced by the trust for the value of the trust assets that are to pass to the qualified charity (what is known as the remainder beneficiary. Secondly, a CRUT is exempt from federal tax on the income from investments it holds. Third, contributions to a charitable remainder trust made pursuant to a will can provide for an estate tax deduction. 26 U.S. Code Section 664 provides the requirements for Charitable Remainder Trusts.
Set up a Donor Advised Fund
A Donor Advised Fund is a great estate planning tool as any assets you put in this trust are not counted towards your total estate value. This account allows your investments to grow tax-free as they are set aside for a charity. However, unlike a normal trust, you remain in control of the money in this account until you decide you want to donate it. Further, if you pass away and there are assets in your account, your heirs can manage and distribute this money.
Set up a Family Limited Partnership or Foundation
A foundation requires you to set up a new organization. While these foundations focus on charity—such as college scholarships, medical research, or business grants—they remain under the control of your estate.
A family limited partnership is an arrangement where you can still manage your investments. However, these assets are also protected from creditors or divorced spouses. When you pass away, the assets left in this trust transfers to your ‘limited partners’ who are usually your heirs. When you transfer the assets, your ‘limited partners’ will receive a tax break on income, estate, and gift taxes.
Invest in a Business Where your Heirs are Part-Owners
You may have a friend or associate who would like to start a business or is looking for someone to invest in their current business. One way to lower your estate tax is to invest in the company if that company will make your heirs part owners. This will allow your heirs to receive monthly income for as long as the business operates.
While this is a risky option, it is a great way to lower your tax liability while continuing to benefit your heirs.
Spend or Give Assets Away
Nothing is stopping you from spending or giving away your assets while you are still alive. You can donate any amount of money to charity and receive significant tax breaks for these contributions. Additionally, spending money while you are still alive could actually save you money compared to the taxes you would pay on assets over the estate tax exemption limit.
Double Your Estate Tax Exemption if you are a Married Couple
A joint revocable living trust is a single trust created by a husband and wife, into which they transfer their assets. The trust provides that while both spouses are living, the trust income and principal shall go to either or both of them as they desire. Finally, any assets remaining in the trust after both spouses have passed away avoid probate and work to lower your overall estate tax burden.
Contact Our DC Law Office for More Information
Finally, for more on how 10 ways to reduce or avoid estate taxes, contact us at 202-803-5676. You can also directly schedule a consultation with one of our skilled attorneys. Additionally, for general information regarding estate planning, check out our blog.