Q. My wife passed away nearly three years ago. I have three adult children. My estate includes mostly cash and bonds as well as my primary residence. I am concerned that my children will have to pay estate tax when I die. How does estate tax work and can I avoid having my children pay tax on their inheritance?
A. The good news is that almost all estates are exempt from paying federal estate tax. This is because the tax was mostly repealed in 2010. For the years 2011 and 2012, the cutoff for estate taxes is 1 million dollars.
How To Avoid Federal Estate Tax
The estate tax is based on everything you own or have a financial interest in at the time of your death. If your estate is valued at or near one million dollar, there are various ways to reduce the estates value so its falls below the threshold amount thereby eliminating the tax liability.
If your estate is a large one, you will want to consider gifting a portion of your estate to others as soon as possible. These are known as tax free gifts. Under estate planning laws, you are allowed to gift up to $13,000 per year, per beneficiary without imposition of a gift tax.
While the law limits gifting to only property and cash, other laws enable you to pay a beneficiaries school tuition and even their medical bills. This will allow you to reduce your estates value and keep it under the estate tax threshold.
Gift Your Money Through A Trust
Another popular option is to gift your money through a testamentary trust, the value of which is legally held outside of the estate for purposes of calculating the net value of the estate, which occurs at the time of your death.
Setting up a charitable trust is another popular option. This will require that you gift a portion of your estate to a tax-exempt charity. Again, what ever is gifted before the time of death reduces the value of the estate and therefore reduces the chance of having to pay estate taxes.
Giving away money to lower the value of the estate does have its requirements. Under the law, you can gift up to $13,000 a year per recipient. Be aware however, that if you gift more then the legal limit per recipient within prescribed period, the government will impose a tax gift. The operative issue here is how many recipients, including charitable trusts, can you gift in order to reduce the value of the estate below the tax threshold.
Consider that if you live another five years and in each of these five years you gifted $13,000 to ten recipients per year, it is easy to see how much this will reduce the value of your estate. The strategy here is to gift the maximum you can to your children, and to any other beneficiaries you choose to and as often as you can under the law.
Finally, you are allowed to reduce the estate tax which includes mortgages and debt, estate administrative expenses and any losses that may have been incurred during the administration of the estate.
State Laws – Growing Trend For Collection Of Additional State Revenue
Given the declining economic conditions of most state budgets, many states have begun to impose estate taxes as a way to make up for their tax revenue shortfall. Some states call it an inheritance tax rather then an estate tax but the effect is substantially the same.
Unfortunately, there are a growing number of states that now impose estate taxes even if you are exempt from the federal estate tax laws. Some of these states include: Connecticut, Indiana, Iowa, Kansas, Kentucky, Nebraska, New Jersey and Oregon. You will want to check with an estate attorney to see if your state is one of a growing number of states that have begun to impose inheritance taxes.
Under the laws of these states, the inheritance tax is imposed upon the decedent’s property once it has passed to the recipients, and in some states the estate tax rate is based on the relationship of the decedent to the recipient of the gift rather then just the value of the estate. Money that is left to a surviving spouse for example is taxed less then it would be if the money was left to a distant cousin.