When an individual dies, their assets are usually subject to what are called estate taxes. If an estate is carefully planned, there are ways to minimize those taxes. Effective tax planning can ease the tax burden on surviving loved ones and also be a way to shield generational wealth. The good thing is that people under a certain threshold aren’t liable to pay estate taxes.
What is An Estate Tax?
Estate taxes also known as death taxes are levied by the federal government and state governments. These assets may include cash, securities, real estate, life insurance, businesses, trusts, or annuities. The fair market value -what they’re worth today- is used when determining taxes on assets. What fair market value means is that the value of those assets may not be the exact amount the deceased paid for them. The total fair value of said assets are referred to as gross estate.
To reduce estate taxes, the IRS makes it possible for people to make deductions like debt from a mortgage, estate admin expenses, or property that is inherited by surviving spouses or qualified charities and more.
Who Pays Estate Taxes?
Estates valued above thresholds set by the Federal government-usually numbers that run into the millions– trigger estate taxes. It’s also important to know that there are federal estate taxes and state estate taxes. While federal estate taxes are mandatory, not all states levy estate taxes and when they do, the threshold varies between states.
The unlimited marital deduction means surviving spouses who inherit an estate aren’t usually subject to estate taxes. That said, when the surviving spouse dies, their heirs may be liable to pay estate taxes.
Estate tax returns are usually only required for individuals with robust or complicated estates. Individuals who have straight forward estate’s don’t often have to file an estate tax return.
Inheritance Tax vs Estate Tax
Sometimes inheritance taxes and estate taxes are conflated, but they are two different types of taxes. While estate taxes are paid by the estate and given to the IRS before beneficiaries receive their cut, an inheritance tax is paid by individuals who inherit the estate. Another important distinction is that inheritance taxes aren’t levied at the federal level, while estate taxes are.
Some states require both inheritance and estate taxes to be paid, while some don’t require inheritance taxes at all. Surviving spouses also aren’t typically subject to inheritance taxes.
Minimizing Estate Taxes
Some individuals may want to minimize their estate taxes so they have more wealth to pass down to future generations. There are strategies that can be implemented to make this possible.
- Gift assets: The assets in an estate can be gifted to loved ones, which can be beneficial since several states don’t tax gifts. Individuals who choose this route should be mindful that giving assets over certain amounts can impact estate taxes down the road.
- Charitable giving: Leaving assets for a qualified charity can also help reduce the tax bill since those contributions are deductible from estate taxes.
- Trusts: A trust is another common strategy people use to shield their assets. When placed in an irrevocable trust, those assets may be legally out of reach from federal and state taxes. Using trusts to avoid estate taxes can be incredibly complex, so it’s important to work with a qualified estate attorney.
If unsure about how to navigate estate taxes, it’s always best to speak to a financial professional, be it a financial advisor, tax professional, or estate attorney.