When a person dies, all property and money left to the beneficiaries can be taxable. These taxes are referred to as either the estate tax or inheritance tax. Fortunately, if you plan properly, it’s possible to avoid it entirely or limit the amount you pay. Here are some tips you can consider to be prepared for this situation.
Know what is taxable
Inheritance tax and estate tax are similar in that they both seek to minimize wealth transfer after death. Understanding how to calculate these taxes will be what helps you to avoid them. Property that can be taxed includes securities, real estate, cash, insurance, annuities, business interests, and trusts. IRS Form 706 goes into more detail about what’s taxable.
Identify what is excluded
Some items can be considered not taxable for the purposes of calculating the gross estate. You won’t be taxed for items solely owned by your spouse or other individuals in most cases. Additionally, life estates that are given to you in which title passed upon your death won’t be included either. Charitable conservation easements, worker’s compensation death benefits, and social security benefits are also not included.
Calculate gross estate
Your gross estate, which is calculated as of the date of death, includes everything you own or have specific interests in that is taxable. Exclusionary property should not be included in this calculation. The fair market value should be used when calculating everything. If you’re unfamiliar, the fair market value is the price that something would sell between a willing buyer and seller if there was no compulsion and a good understanding of the relevant facts.
Tax liability can be reduced by subtracting allowable deductions from the gross estate. After you do this, the remaining amount is your taxable estate. Some of the things you’ll be able to deduct include charitable deductions, marital deduction, debts and mortgages, losses during estate administration, administration expenses of the estate.
Identify any taxable gifts
According to federal law, lifetime gifts have to be reported, and any gift tax you might owe is calculated yearly. After your death, those gifts are added back into your estate for calculating estate tax. As a result, you possibly end up paying taxes on the wealth that you gave away, as well as the wealth that was kept and accumulated. In most cases, taxable gifts are gifts made after 1976 which were not qualified gifts for medical or educational purposes, or transfers that qualify for marital deduction, charitable deduction, or annual gift tax exclusion. The value of the gift should be the fair market value.
Know if your estate is taxable
In 2019, $11.4 million was the amount for applicable exclusion. A filing would only be required if your cumulative taxable transfers exceeded the exclusion amount. If it does not exceed it, then you won’t need to file an estate tax return, and you won’t own any federal estate taxes. As an example, if your cumulative taxable transfers were $9 million in 2019, you would not have had to file an estate tax return. Be sure to check the amount for the current year, as the amount can change from year to year.
Identify Tentative Estate Tax
To get your tentative estate tax amount, it will equal your tax on cumulative taxable transfers minus the tax on adjusted taxable gifts. Your tax on cumulative taxable transfers is calculated according to the unified tax rate schedule. The top tax rate in 2020 is 37%. Your tax on adjustable taxable gifts can be subtracted because those were taxed during your lifetime through your yearly gift tax. When you’ve got your tentative estate tax calculated, you’ll be able to begin subtracting different credits from that amount. The largest credit is usually the unified credit. Once all calculations are done, you’ll have your final federal estate tax amount.
Determine state liability
You can use your calculations to determine your taxable estate. If it exceeds the exemption threshold for where you live, you might want to consider moving to avoid the tax liability. It’s possible to establish an alternative residency in a jurisdiction that does not have an inheritance tax. The relocation can be permanent, or you can divide your time between your old residence and your new one. If you plan to do that, make sure you establish a record that supports your claim of a new residency. Examples of records you could establish include forwarding your mail to a new address, getting a voter registration, or getting a vehicle registration.
Know the transfer rules
If your surviving spouse will be the heir to your estate, no applicable federal estate tax applies as long as the spouse is a U.S. citizen. If the spouse is not a U.S. citizen, you’ll need to do some estate planning in order to leave a special trust to them. Nonetheless, the estate will still be taxed once the surviving spouse dies. As of 2020, the first $11.58 million of an estate is exempt from being taxed. If your estate was valued at $16.58 million, only the second $5 million would be subject to taxation.
Give money to future heirs
An individual can receive up to $15,000 a year without being taxed. After the yearly limit is reached, all other transfers are subject to be taxed as a gift. While there’s a limit of about 11.58 million in tax-free gifts per lifetime, future heirs can receive $15,000 per year indefinitely until that point is reached. Additionally, the money can be deposited in a trust where it can be protected and accumulate over time.
Limiting the amount of estate or inheritance tax that has to be paid takes planning. Be sure to know the information specific to your state, and then manage your finances accordingly. When it comes to managing all of your taxes, a tax return calculator can be useful too. You can learn more about it at this link: https://taxfyle.com/income-tax-return-calculator/.