Two different types of death taxes exist: estate tax and inheritance tax. Estate taxes are taxes imposed on a decedent’s estate before distributions are made to beneficiaries, whereas inheritance taxes are imposed on the beneficiaries who receive the windfall.
Read on to learn how you can minimize the impact of death taxes.
Ways to Minimize Your Estate Tax
As of 2018, the exemption is $11.2 million per person before you owe any federal estate taxes — and the IRS doesn’t impose a federal inheritance tax.
Some states have their own death taxes with different inheritance tax rates and inheritance tax rules — which means that even when you die, you could still be on the hook for paying death taxes as a result of your passing. Here are six ways to minimize your estate tax burden:
1. Leave the Money to Your Spouse
If the decedent is married, he can leave an unlimited amount of money to his spouse without incurring any tax — as long as the spouse is a U.S. citizen. Each taxpayer also receives the exemption, which is excluded from federal estate tax. Any unused portion of the exemption can also pass to the surviving spouse through portability.
“The rules here are complicated, so to ensure both spouses are able to each use the full exemption amount, a living trust or creation of a will with specific provisions may be advisable,” said Pamela Kornblatt, president of Tax Strategists, a company that provides personalized tax preparation and advice.
2. Contribute to Charity
Money that goes to qualifying charities at your death is exempt from federal estate taxes.
For example, if your estate exceeds the federal estate tax exemption by $1 million but you leave $1 million to charity, you won’t have to pay any federal estate taxes. You can also give away as much as you want during your lifetime to charity without it being considered a taxable gift. Plus, contributions made during life qualify for charitable income tax deductions.
3. Give Your Money Away During Life
“Giving away the money over time to those who would ultimately be the beneficiaries of the estate is a good idea,” said Kornblatt.
Significant estate tax savings can be achieved by removing assets from the estate beforehand — in other words, gifting. The annual gift tax exclusion allows you to give away up to $15,000 per person tax-free.
Gifts for tuition and medical expenses paid on behalf of someone else — such as a grandchild — and gifts to political organizations are also exempt from the gift tax.
4. Create an Estate Plan
Meeting with an estate planning attorney can help you implement estate planning options to minimize — or eliminate — the impact of estate taxes on your loved ones. Doing so will transfer more of your hard-earned assets to your intended beneficiaries if you have a large estate.
These can include qualified personal residence trusts, family limited partnerships, and charitable trusts.
5. Remove Life Insurance Proceeds From Your Estate
If you own life insurance on yourself — or if your estate is the beneficiary of your policy — the proceeds are included in your taxable estate. With a little planning, you can create irrevocable trusts designed to hold the insurance policy and remove the death benefit from your taxable estate.
“Setting up an irrevocable life insurance trust is another great strategy as it allows the taxpayer to remove the value of his life insurance from the estate,” said Kornblatt.
If you have a taxable estate, the cost to draft and implement the trust can easily be outweighed by your tax savings. Consult a financial planner or tax adviser to determine the best trust structure for you.
6. Move to a Different State
You probably didn’t pick where you live based on the state’s death tax laws, but where you live can affect how much you’ll pay in estate taxes.
If you have a sizable estate, each state’s estate and inheritance tax laws could affect where you choose to retire. The following lists outline which states collect estate tax and inheritance tax:
States That Collect Estate Tax in 2018
Here are the states that collect estate tax:
- District of Columbia
- New York
- Rhode Island
States That Collect Inheritance Tax in 2018
Here are the states that collect inheritance tax:
- New Jersey
Some states follow the same exemptions as the federal estate tax, whereas others operate separately — which could leave some residents with state estate tax to pay, even if they’re exempt from the federal estate tax.
For example, in Oregon, the state estate tax exemption is only $1 million with a top tax rate of 16 percent. Alternatively, Maryland has a $4 million exemption for estate taxes — plus the state also imposes an inheritance tax.
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