Tips to Minimize Estate Taxes with Proper Estate Planning

Estate planning is often an ignored subject, yet an important one which should be on the top of your priority list. More than half of the adult U.S population is yet to make a will. The absence of a will could prove to be disastrous for their children if a tragedy were to strike. As per intestacy laws, if both parents die without a will, the government decides how the estate gets divided. This may not always work out in your family’s best interest.

Planning beforehand can be an effective way to save you from many misfortunes. It saves time and money and ensures that your family is not caught up in legal affairs at a rather difficult time in their life. It also keeps them from paying high estate taxes. Let’s understand how. 

What is an estate tax?

An estate tax is a tax levied on the estate of a deceased person when its value exceeds a certain threshold, as determined by federal and state laws. As of 2019, the federal estate tax is levied on assets beyond $11.4 million. However, this does not apply to assets that are transferred to the surviving spouse.  Most states have their own regulations and limits. The estate tax has always stoked controversy with opponents calling it “the death tax”, and proponents referring to it as “the Paris Hilton tax” (named after the popular hotel heiress). 

How can proper estate planning help you eliminate or minimize tax?

If you want to reduce or put an end to your estate tax load, you should be mindful of the following: 

1. Know your value

Many middle-class families do not make a will, and assume that estate planning is only for the wealthy. They also lack knowledge of the real value of their assets. Assets like, bank accounts, properties, business assets, life insurances, retirement accounts, etc., together determine the size of an estate. People generally underestimate the value of all their assets when combined together.

2. Spend appropriately

Sometimes, spending from your wealth could reduce the size or value of your combined assets, thereby reducing your tax liability. However, you need to be wise with your expenses, or you can end up spending all your savings.

3. Give gifts

An individual can give a gift of up to $14000 annually, to as many people as they want. Gifting portions of your wealth to your children and grandchildren can be a good start. Over several years, this could drastically reduce your taxable amount.

4. Give money in charity

Most billionaires resort to charitable endeavors to bypass some of their estate tax liability. Creating a trust, such as a Charitable Lead Trust (CLT) or a Charitable Remainder Trust (CRT), can shield your assets from estate taxes. A financial advisor can help you understand if you qualify to register a 501(c) non-profit organization.

5. Form a Family Limited Partnership (FLP)

An FLP is created by forming a general partnership and then declaring family members and heirs as limited partners in it. It divides your high-value assets among all the heirs (or general partners), while you still retain control over major decisions. In addition to providing flexibility and revocability, a family limited partnership is a handy tool to protect family assets from creditors.

6. Get married

Estate planning is especially important for unmarried couples. According to state laws, an unmarried person’s assets are inherited by their biological relatives. This leaves nothing to the unmarried partner. On the other hand, as per the federal tax exemption rule, a married citizen can leave assets for their spouse without incurring any tax liabilities. There is also no upper limit for this clause and it includes same-sex marriages too.

However, many argue that in truth, this merely defers the estate tax. When the widowed spouse passes away too, the estate is likely to be taxed anyhow. Despite the arguments against the idea, it is still a good way to evade tax and can be useful to some people in certain circumstances. So, if you are already in a relationship, taking it to the next step and tying the knot can help you save on your tax liability.

7. Remove life insurance income from your estate

The proceeds from your life insurance are included in your taxable estate. Purchasing or transferring your life insurance to an irrevocable living trust, designed to hold the insurance policy, can help you reduce the value of your estate. The trust gives you the benefit of keeping your money intact for years, with the option to distribute some of it to your spouse or children periodically.

8. Establish a Qualified Personal Residence Trust (QPRT)

A QPRT transfers your house to a trust, generally for a period of 10-25 years, while giving you the right to live there. After the trust expires, the house is passed on to your heirs at a reduced value. A QPRT can help you reduce your estate value almost immediately, as the house is no longer counted as a valuable asset.

9. Move to a different state

Just like the state laws, tax rates may also differ across states. You should consider retiring in a state which provides good tax-benefits.

10. Transfer your assets to a Grantor Retained Annuity Trust (GRAT)

This works much like a QPRT and allows you to transfer your income-producing assets, like stocks and real estate, to a trust, while still retaining the income from it. The trust is generally specified for a period of time after which the assets are passed on to the beneficiaries.

11. Evaluate the correct value of real estate

In most cases, real estate is estimated at its highest value, which could at times provide unfair results. The Internal Revenue Code allows real estate to be valued at its current value rather than its best value, thereby helping you determine an accurate estate tax. 

To sum it up 

Since estate planning usually involves a huge sum of money, even a small change could make a significant difference. Leaving it unaddressed can make matters worse. It is advisable to plan as early as you can, so your money goes to the rightful heirs, rather than being languished at the government’s mercy. 

Following ever-changing legal and financial laws, associated with estate planning, can be an ordeal. Consult a financial advisor to simplify the complexities and understand the nuances of estate planning.