One of the most common concerns in estate planning is estate taxes. In fact, one of the basic goals of estate planning is either decreasing estate taxes or eliminating them altogether. With the current federal estate tax rate at 40%, it is easy to see how taxes could potentially reduce the value of your estate to a large extent. Estate taxes must be paid from any gross estate exceeding $5.45 million. Many, if not most estates, are not required to pay estate taxes because of Estate Tax Exemption. But, if your estate is not exempt you may want to find ways to avoid estate tax.
The history of estate taxes in our country
Federal estate taxes have been around for a long time – since 1918. Not long after the estate tax law was passed, citizens began transferring assets to their children, grandchildren and other, in order to reduce their taxable estate. That led to the creation of the gift tax as a way to counter the attempts at estate tax avoidance. In 1976, these two taxes were combined. The question many clients have now is, can estate taxes be avoided?
Use the estate and gift tax exemption
The current (2016) exemption amount for estate and gift taxes is $5.45 million. This means that you can either bequeath or give away up to $5.45 million in assets, without an estate or gift tax being imposed. As long as your estate is valued at less than this amount, you will be able to avoid federal estate taxes entirely. The annual gift tax exclusion amount is $14,000 for each individual or a total of $28,000 for married couples.
What happens if I exceed the annual exclusion?
If you exceed the $5.45 million lifetime exclusion amount, then you will be required to pay 40% on the amount of your estate that exceeds that amount. However, making proper use of the marital deduction, can also reduce this amount. Married couples are allowed to give a gift of an unlimited amount to their spouse. The value of the property that passes to the surviving spouse is deducted and the amount of this deduction is unlimited, in most cases.
Use the marital deduction to eliminate estate taxes
For married couples, there is another way to avoid paying estate taxes. If all assets go to the surviving spouse, then no taxes would be due based on the “marital deduction.” According to federal estate tax law, the marital deduction is unlimited, meaning that all assets left by one spouse to the other are deducted from the taxable estate. A married couple can essentially protect $10.9 million from federal estate and gift taxes. This is often referred to as the lifetime credit.
Use a trust to transfer ownership of assets
In order to take full advantage of the lifetime credit, married couples should create a “bypass trust.” In their wills, the spouses can stipulate that, upon their death, all assets up to the amount of the unified lifetime credit ($10.9 million) will be transferred to the bypass trust. The income from these assets will then flow directly to the surviving spouse. Once both spouses have passed away, the ownership of the remaining assets will be transferred to the named beneficiaries and the bypass trusts would be dissolved.
Consider a generation-skipping trust
A “generation-skipping trust” is basically a second-generation “bypass trust.” The gift of the income created by the assets is separate from the gift of the assets themselves. So, an individual can include terms in the trust that a specified amount of assets in the estate should be transferred to their grandchildren while the income from these assets is distributed to one or both of their parents. This can be set up for a specific length of time, or as long as the parents live. After the death of their parents, the grandchildren then receive the income from these assets and gain control over the assets themselves.
Living trusts do not avoid estate taxes
Not every type of trust provides estate tax avoidance. A living trust does not save on taxes because you retain the ability to amend or revoke the trust at any time. Estate taxes can only be avoided if the assets are effectively removed from your estate. But since you can take back your assets at any time, in reality, you still own those assets. As such, federal tax laws include living trust assets in your estate for the purpose of estate taxes.
If you have questions regarding federal estate taxes, or any other estate planning needs, please contact the Schomer Law Group either online or by calling us at (301) 337-7696.