Common sense applies: Just because I post this and you read does not make me your attorney and does not make you my client. Every situation is unique and you should always consult an attorney when creating legal documents.
We are discussing obstacles that stand in the way of transferring your estate to your heirs and are continuing on the subject of “death” taxes. Death taxes include the Federal Estate Tax and, potentially, an inheritance or estate tax imposed by the state of your residence.
The Federal Estate Tax starts with a broad inclusion of all the assets you owned or controlled at the time of your death. Like your personal income taxes, you can think of this figure as the “gross” but in this instance it is the gross estate.
The next step then, is to see what may be properly excluded from the gross estate in order to determine the gross taxable estate.
I am not going to cover all the technical possible exclusions, but I do want to discuss three major exclusions: Charitable, Marital, and Exemption.
Charitable Estate Tax Exclusions
This exclusion is straightforward to understand and apply. Any part of your estate left to charity (including churches and religious organizations) is excluded from your gross estate. It is not subject to taxation. This is a useful provision. Not only for the wealthy, but for any person who desires to structure estate plans to benefit society. They can do this through the charitable use of their wealth. This is an important aspect of the legacy that a person wishes to establish.
There is even a leveraging factor if you designate traditional retirement plans to transfer to charitable or religious organizations. This includes 401(k)s and IRAs. Those assets are not included in your gross estate, and therefore not subject to the Federal Estate Tax. In addition, the recipient will not have to pay the income taxes that were deferred when you made the original contributions.
Marital Estate Tax Exclusions
This exclusion is also straightforward to understand and apply. Any part of your estate left to a surviving spouse is excluded from your gross estate. And is not subject to the Federal Estate Tax. This is a very powerful planning tool and a tremendous advantage enjoyed by married persons in our society. Typically, when a spouse survives, there will be zero Federal Estate Tax owed by reason of the deceased spouse’s death. This is because most, if not all, of the assets will transfer to the surviving spouse.
Exemption Estate Tax Exclusions
This is the amount set by the government which is excluded from every estate, and which was discussed in the last post. The current exemption is set at $11.4 million per person and is indexed (increased) annually to account for inflation. Such a high level of exemption means that most people will not have a taxable estate when their assets pass to their heirs. However, it is important to remember that this is a legislative creation and can be changed easily by future political action.
Any portions of estates that exceed the $11.4 million threshold are taxed at 40%, which is a high rate of taxation. It is therefore quite advantageous to your heirs to be sure to eliminate any potential taxable estate.
Gifts and your estate
Gifting is a popular and easy way to transfer assets out of your estate before you die. By gifting, you are thereby reducing your gross estate that will be considered for taxes. Currently, you can give up to $15,000 in cash or property to any person or entity in a given year without incurring any negative tax consequences. So, year-end gifts to 5 college funds for grandchildren is a quick reduction of $75,000, as well as a great legacy for those children.
Again, there is a leveraging aspect available in gifting. If you gift your RMD to a charity or religious organization, they will not have to pay income tax on that gift, and you have removed that amount from your gross estate. Similarly, if you have assets that have appreciated significantly in value, gifting those assets to church or charity not only removes the value from your gross estate, but those tax-exempt organizations will not have to pay capital gains taxes when the assets are sold.
Good estate planning can utilize the three exclusions we discussed and can gain good advantages by using them in combination with each other and applying them to specific assets.
Learn more about estate planning in my previous articles, listed below, or contact me with your questions.
Part 4 – Estate Planning – Estate Tax
Part 3 – Estate Planning – The Probate Process – Attorneys
Part 2 – Estate Planning – Key Benefits
Part 1 – Estate Planning – An Introduction
In the next post, we will wrap up our discussion of “death taxes” and start to consider the third obstacle of estate planning: probate.
Troy