When many people hear the words estate plan, they often think only about their Last Will and Testament. After all, most people view their wills as an indispensable document that disburses their assets to loved ones after death. And since that is the primary concern many American have when it comes to end-of-life planning, it is only natural that they consider a will to be the only thing they need to consider. The problem is that your Last Will and Testament might be the foundation of your plan, but it encompasses only a part of the overall strategy you need. If you fail to consider other factors, like taxes, you could undo everything that you try to accomplish with that will. If you fail to properly take taxation concerns into consideration, estate taxes could derail your entire estate plan.
What is the Estate Tax?
At the federal level, the estate tax is a tax levied on the combined total value of a deceased’s assets at the time of death. The tax is calculated based entirely on what is considered the “fair market value” of the assets, rather than their purchase price or previous value. Assets assessed during the calculation process can include everything from real estate and businesses to cash, stocks, trusts, and more. There are deductions applied, gift value assessed, and credit reductions used to determine the final tax assessed against the estate.
The Impact of Estate Taxes on Your Estate Plan
No matter how carefully you plan out the management of your estate, it could all fall apart when you die if you neglect to take estate taxes into consideration. If your estate is large enough to be subject to this tax, it will have to pay the taxes due nine months after you pass away. Your representative will have to make some serious decisions to figure out where the money will come from, since the IRS won’t accept anything other than legal tender as payment.
Here’s the thing, though: if your entire estate – or most of it – consists of real estate, valuable items, stocks, or business interests, then chances are that those assets make up the bulk of the inheritance your estate plan is designed to distribute to your heirs. Your Last Will and Testament almost certainly will contain detailed provisions outlining which beneficiaries receive which assets. If you’re detail-oriented, then almost everything of value will be accounted for in that dispersal plan.
When estate taxes are due, however, there are only a few real options available for paying the IRS:
- Use the estate’s cash reserves to pay off the tax obligation. This option is always the easiest when the estate has liquid bank assets that can be obtained in relatively quick fashion. Obviously, that will reduce the amount of assets available for dispersal to the deceased’s heirs, but that’s just something that cannot be helped. The government will demand that it be paid first.
- If there are no cash reserves, stocks and bonds are often the next best thing. In most instances, they can be readily liquidated to provide the cash needed for payment. The major drawback here, of course, is that the heirs who would have received those securities and bonds will have to forfeit their ability to sell when the price is high. If the sale has to occur during a down market, that can mean a tremendous loss in the overall value of the estate and the inheritance it offers.
- Draw upon life insurance payouts. This option only works when the insurance policy was set up to pay out to a revocable living trust, since that enables the trustee to collect the payout fairly quickly and settle the tax obligation. It is not an option if the policy is set up in a way that pays the money directly to the deceased’s beneficiaries.
- A lack of liquid assets could force the estate to sell of tangible property like real estate or stocks, or borrow against those assets to pay the debt. Again, this can result in a sale of assets at inopportune times, and reduce the overall value of the estate to the designated beneficiaries.
- Try to obtain an election that extends the time to pay out over several years. Unfortunately, this option is only available for certain types of asset-holding estates, usually involving things like farming interests or other types of businesses. Keep in mind that this option rarely works, since it involves a complex set of requirements – each of which must be met for the estate to qualify for the election.
Naturally, being forced to sell off assets or pay tax obligations directly from cash reserves will severely impact the inheritance that beneficiaries are able to receive. That can significantly alter the estate plan that you worked so hard to develop. That makes it even more important that people use professional estate planning strategies during their lives, so that their estates are properly protected when they die.
There is good news, though. There are advanced planning strategies that can help to minimize any potential estate taxes that may be assessed when you die. These techniques can help you to reduce those taxes without disrupting the income stream you need to maintain your lifestyle while you are still living. They include things like gifting strategies, charitable trusts, and the use of qualified personal residence trusts and annual exclusion gifts.
The ultimate goal, of course, should be to ensure that your estate plan is not derailed by an unexpected application of the estate tax. Florida residents are fortunate that theirs is not one of the several states in the nation that imposes its own estate or inheritance tax, so they can focus their estate planning attention on avoiding the federal version of the tax. In most instances, however, those efforts will be in vain without competent assistance from a professional estate planner. Robert Kulas Attorneys at Law in Port St Lucie and Vero Beach FL can assist you with all of your estate planning needs and ensure that the fruit of all your hard labors can be passed on to your heirs in accordance with your desires. To find out more about how we can help you limit your estate’s exposure to the estate tax, contact us today.
