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Estate Planning Basics

One big concern when designing an estate plan is taxes. After all, it’s the means by which you transfer wealth to inheritors. The act of giving away your property may be subject to taxes on the state or federal level, or even both.

In fact, these taxes could be the largest expense your estate may have to pay. Understanding what these taxes are, how they work, how they may affect your estate, and how they can be minimized is vital to a successful estate plan.  

Estate Planning Tax Basics

While estate taxes technically refer to taxes imposed at death, there are two taxes which have a wide influence on the estate planning landscape: 

Transfer taxes – taxes imposed when someone gives away property to someone else when they’re alive or dead. Transfers made when a person is alive are gifts, which are taxed yearly. Transfers made when someone is deceased are legacy, bequest, or in-estate succession, all of which are subject to estate taxes upon the giver’s death. 

Income taxes – Under federal tax law, a person’s estate is classified as a separate legal entity. The executor of the deceased’s estate may have to file an income tax return for an estate, and another return for the deceased’s final year of income earnings. Income sources within an estate may include real estate property holdings, interest earned in a bank account, or income not paid to the decedent before death.   

Other Estate Planning Fundamentals

At the federal tax level, most American households won’t have to pay estate tax. Only estates worth over $5.3 million will have to pay the federal government (for deaths in 2015). Estate taxes must be paid within nine months of the decedent’s death date.

Other important notes:

  • Gift taxes and estate taxes are wrapped up in a “unified” tax system
  • This is so you can’t escape tax liability with property giveaways when you’re alive
  • Upon death, all taxable gifts are included in the gross estate to calculate the estate tax owed
  • As a result, you pay taxes on the cumulative wealth you’ve given away
  • This happens even if the gift taxes were already paid during the deceased’s lifetime 
  • Gift tax is deducted from estate taxation owed, if any


How to Reduce Estate Tax Impact?

estate insurance basics img 1One way is through an estate freeze technique. This is a measure which allows you to freeze your estate’s present value and pass on future growth to your estate successors. A variety of estate freeze techniques are available.

Estate tax liability may also be reduced with this approach. The unified tax system permits applicable exclusion amounts that lower gift tax or estate tax liability. In the case of gift taxes, the exclusion amount is set at $1 million, and for estate taxation purposes, it increases. These techniques vary in their complexity, and they include actions such as installment sales, gifts, private annuities, or sales-leasebacks. 

Any applicable exclusion amount you use for gift tax purposes effectively reduces the applicable exclusion amount that will be available to you at your death. In planning for estate tax expense, you should estimate what the amount of your estate taxes may be so that you can arrange to replace the wealth that’s lost if you have specific gifts you’d like to make.

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More Information on Estate-Related Income Taxes:

Income taxation of trusts:

A trust may be a taxpaying entity. If your plan includes the use of a trust, your trustee may be required to file an annual return and pay income tax on the trust income.

Decedent's final income tax return:

If you earn income during the year in which you die, your personal representative will need to file your final income tax return and pay any income tax that may be owed. The funds to pay will come from your estate. Your tax year ends on the date of your death.

Income taxation of your estate:

Your estate is considered a separate tax-paying entity by the IRS. Your personal representative must file and pay income tax on any income your estate receives, including interest from bonds or dividends from stock.

Different Kinds of Transfer Taxes

A transfer tax is imposed when you give your property to someone else. There are six types of transfer taxes to which you or your estate may be subject:

State gift tax:

estate planning basics img 2A gift is a transfer of property you make during your lifetime. In such a transaction the giver is designated the donor, and the person or organization you give to is called the done. When you make a gift, it is in exchange for nothing, or for property of lesser value. 

In other words, it's not a bona fide sale. Generally, gifts must be reported and gift taxes paid in the year following the year in which the gift is made. 

If your state imposes a gift tax and you intend to make lifetime gifts, contact an attorney or your state's department of revenue or taxation to find out what gifts need to be reported, how to compute the gift tax, and when and how to file a gift tax return. Currently, only a few states impose a gift tax.

State generation-skipping transfer tax:

The GSTT is imposed on property transferred to a family member who is two or more generations below you, such as a grandchild or great-nephew. Contact an attorney or your state's department of revenue or taxation to find out what transfers may be subject to state GSTT, and when and how to file a return. Only some states impose a GSTT.

Federal gift and estate tax:

Generally speaking, federal gift and estate tax is imposed on property transferred to others either while you are living or at the time of your death. Unlike the individual states, which impose at least one type of death tax and may or may not impose a gift tax, the federal tax system is unified. 

The IRS adds lifetime and at death transfers and taxes them according to one rate schedule.

Need help navigating the estate planning process and lowering your tax burden? Our knowledgeable Safe Money Team can help – call us today at 877.GROW.SAFE (877.476.9723) for immediate support.

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