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Working hard and building wealth to leave behind a legacy and provide for family members requires intense estate tax planning. A will can leave a loved one an estate, but the IRS can take as much as 40% of the estate's wealth in taxes in 2020.
What Does Estate Tax Planning Involve?
Estate taxes change over time, with the current exemptions at an all-time high.
"First, the federal estate and gift tax exemption is at a historic high of $11,580,000 in 2020—$23,160,000 for couples if portability is elected on a federal estate tax return," explains Kiplinger.
High net worth individuals can reduce the tax that their beneficiaries have to pay on the estate with advanced tax planning measures.
The practice of estate planning makes it easier and less complex to transfer the estate to loved ones.
When an estate is left to loved ones, they'll have to pay probate expenses (if no living trust exists), income taxes, and federal estate taxes. Depending on the state in which your beneficiaries reside, they may have to pay estate tax or inheritance tax.
Taxes are typically paid within nine months of death. Since a lot of estates are rich in assets and not cash, the estate will often have to liquidate assets to pay off the estate tax. For large estates that may have large parcels of land, it's not uncommon for a large portion of the land to be sold to satisfy the tax bill.
Vehicles, homes, art – any asset can be liquidated to satisfy the tax burden.
Proper estate tax planning will work to lower or avoid estate taxes, leaving the estate as close to "whole" as possible. Reducing estate taxes must be done while you're alive. An attorney specializing in estate planning can implement strategies to lower the tax burden on the estate.
Common Estate Tax Planning Strategies
An attorney will analyze the estate to determine which strategies to implement to reduce the tax burden on the estate. The most common strategies include:
Leverage Both Tax Exemptions
Married couples enjoy what is known as "portability." Portability allows for unlimited deduction for transfers to the surviving spouse. The estate will have to pay taxes after the surviving spouse perishes unless proper planning is in place.
It's important to leverage both exemptions, each worth $11,580,000 in 2020. This is a complex strategy that requires the first spouse to create a living trust where the estate can leave the $11,580,000 in a trust and the remainder to the spouse.
Since the funds are going into the trust, the first spouse to perish is effectively using his or her exemption. Otherwise, when the surviving spouse dies, only his or her exemption is allowed.
The living trust can be created in such a way that the remaining spouse can use the assets, or special directives can be added for the management and/or distribution of the trust.
While you're alive, you can provide tax-free gifts to as many people as you wish per year. In 2021, this annual exclusion is capped at $15,000. You can leave the entire family gifts per year to lower the estate's value, pay less in estate taxes, and potentially bypass taxes completely.
Married couples can gift $30,000 per year to as many people as they wish.
Excess gift amounts will be taxed. You can also provide unlimited gifts, if paid directly, for:
- Medical expenses
Grantor Retained Annuity Trust (GRAT)
A GRAT is a trust wherein the value of an asset is frozen. An estate will transfer assets or investments into a GRAT for a specified period of time. The estate can still receive income from the trust plus interest that's based on the federal rate.
When the trust reaches its end, the value of the assets is a taxable gift.
The beneficiaries may also receive extra growth tax-free if the assets appreciate at a higher rate than the set federal rate.
Qualified Personal Residence Trust (QPRT)
A QRPT is another type of trust where a personal residence is added to the trust. The residence will remain in the trust for a specified period of time, but you can still reside in the home at this time. When the trust term is over, the home is transferred to the beneficiaries.
Since the residence stays in a trust for a long period of time, the gift value is reduced, helping lower the tax burden.
You can also set up multiple trusts not mentioned, including:
- Irrevocable life insurance trusts, which keep benefits from being part of the estate
- Charitable remainder trust
While you're alive, you can also remove assets from the estate, spend money, gift assets, and lower the value of the estate in the process. Life insurance can also help pay down estate taxes, too.
Exemptions allow for most estates to not pay any taxes, but high net worth individuals may have estates worth far more than the allotted exemptions. Utilizing the strategies outlined above can help pass on as much wealth as possible to loved ones.
Consultant with an Experienced Florida Estate Tax Planning Attorney Today
Estate tax planning can be a confusing and stressful process to navigate alone. Working with an experienced estate planning attorney is a worthwhile decision when determining what you need to set up for your future. For further guidance, consult with an experienced estate planning attorney today.