Despite the fact that it is something that affects only a tiny portion of estates each year, the estate tax is viewed with dread by many people across the country. Others simply resent the thought of having the government tax at death wealth that they already paid taxes on while they were alive. Whatever their reasons, the fact remains that most people want to avoid the estate tax whenever possible. Good estate planning can help in that regard, and can help people to better understand the federal estate tax and how it may impact them.
What Is the Estate Tax?
The estate tax is exactly what its name proclaims it to be: a tax on your estate. While some think of it as a death tax, and others refer to it as an inheritance tax, it is in reality neither of those things. It is a tax that is assessed against certain estates when those assets are transferred after death. At the federal level, this tax has three components that together form what is commonly known as the Unified Transfer Tax:
- Estate Taxes
- Gift Taxes
- Generation-Skipping Transfer Taxes
Sound estate planning is useful for estates subject to these taxes to ensure that tax liability is avoided or minimized as much as possible.
How is the Tax Calculated?
The estate tax is assessed based on the value of all of your assets at the time you die. That includes your home and investment properties, any businesses that you own, bank accounts, investment accounts, individual retirement accounts, and life insurance. The current federal tax rate on those assets is set at forty percent for those assets that exceed the current estate tax exclusion amount, which is set at $5.45 million for 2016. That exclusion amount is indexed to account for inflation, so it will change in coming years.
Note that there is a lifetime gift exclusion that applies as well. That basically takes the total value of your gifting activities over the course of your life and then deducts that amount from your estate tax exclusion amount. Similar provisions are in place to deal with so-called generation-skipping transfers.
Who Pays the Estate Tax?
As noted above, the tax is technically a tax levied against the estate. While it is true that the taxation actually reduces the value of the estate – and thus reduces the amount of wealth available for transfer to the estate’s named beneficiaries, the technical reality is that the tax liability is assessed against the estate itself based on its intact value at the time of the decedent’s death. As a result, the tax is paid using the assets in the estate, which means that the estate pays it.
How Can You Minimize its Impact on Your Estate?
There are a variety of ways for individuals to minimize their estate tax liability at the federal level. It is important to understand these techniques so that you can preserve as much of your estate as possible and avoid being subject to these taxes:
- The annual gift tax exclusion is currently set at $14,000 per year. These gifts do not count toward the federal gift tax lifetime exemption, and enable you to transfer that $14,000 to individuals of your choosing on an annual basis. This reduces the value of your estate, leaving fewer assets subject to that estate tax calculation, and can be a great way to provide your heirs with part of their inheritance while you are still around to see them enjoy it.
- You are allowed to make direct payments to schools and hospitals to pay for others’ tuition or medical expenses, and these gifts will not affect your lifetime gift exclusion either.
- By setting up a qualified personal residence trust, you can effectively pass assets to heirs and freeze the asset’s value at the date of transfer. That enables your estate to avoid any appreciation that might have otherwise accrued in the years between the transfer and your death.
- You can establish irrevocable trusts to separate your life insurance policies from the rest of the estate. The trust then ensures that the policy payouts are directed to your heirs when you die.
- Sizeable estates often use foundations and charitable trusts to provide payments to family members and charities after the grantor passes away. Charitable trusts are an excellent way to continue to make a difference in the community while avoiding estate tax obligations.
Does Florida Have an Estate Tax?
The really good news for people who might be subject to the federal estate tax is that the state of Florida has no current estate tax. Neither does it have an inheritance tax. As a result, Florida residents with large estate only have to concern themselves with federal estate tax matters.
Taking Action
If your estate is large enough to be subject to the tax, it is important to have sound estate planning in place to minimize the amount of your wealth that is ultimately affected by the tax requirements. For while only about 5,000 estates ended up paying that tax in 2015, those estates represent 5,000 instances in which the decedent’s heirs had their inheritances reduced as the estate’s value shrank. The problem most Floridians face in this area is the same challenge all Americans confront: federal law is so complex and difficult to understand that the average citizen has almost no hope of protecting his interest on his own.
At Robert Kulas Attorneys at Law, we have the estate planning experts to help you navigate the complexities involved in preparing your estate so that its tax liability is minimized as much as possible. We’ll work with you to explore the different strategies available to you and identify those that will provide you with the best options for reducing your tax obligations and protecting your hard-earned wealth so that it goes to your loved ones rather than to the federal government. To find out more about how we can help you make sense of the federal estate tax and its impact on your estate planning, call us at (772) 398-0720 or contact us at our website today.
