How To Avoid or Reduce Estate Taxes

Estate taxes do not, by and large, affect the vast majority of Americans, but to those who plan to leave millions upon their death, it pays in spades to understand recent changes to federal estate tax laws. Thanks to the American Taxpayer Relief Act of 2013 (ATRA), estates that are below an inflation-adjusted threshold amount will not be subject to the federal estate tax. For 2016, the adjusted exemption will be $5.45 million. Another important provision is the “portability” feature for spouses. Spouses may now combine their tax credits, giving a surviving spouse the ability to use his or her deceased spouse’s unused credits, in addition to his or her own credits, to pass on up to $10.90 million at death. Other changes and ways to save money are discussed below. Like so much of estate planning, it’s important to at least consult with an estate planning professional to make sure your plans unfold according to your intentions and to save as much on estate taxes as possible, leaving more in your estate to pass on to loved ones, friends and charities.

Spousal Gifts

Under current IRS law, you can give unlimited gifts to your spouse. In other words, if you are nearing your death and do not wish to be encumbered with a will, you can simply give all of your property and wealth to your spouse, tax free. There are however a few catches with this rule. For instance, the gift must be given at least four years before your death. Otherwise, certain states will still include the gift in your estate. However, if your spouse is not a US citizen, the annual limit is $148,000 in 2016 ($147,000 in 2015).

Gifts to Others

If you have large amounts of money in your estate and would like to enjoy the gratitude associated with giving away that money, you may wish to consider gifting the funds early. A single person can gift $14,000 to each person annually. A couple can double this to $28,000 in gifting to their children. These gifts are tax-free and permanent. These gifts are also not limited to money in your estate. For instance, if your client has a summer home in Italy that they would like to give to their adult child, you can gift $28,000 of the home to that child annually. Other examples of gifting that are common to estate planning include paying for a grandchild’s college education, setting up college savings funds for great-grandchildren, or paying the medical costs for a sick relative. Keep in mind that gift giving is only one means of emptying your estate. If you would rather retain your wealth until your death, there are ways to ensure you are provided for as well.

Trusts

Another means of avoiding estate taxes is setting up a proper trust before you die. Remember that only trusts established before your death will avoid estate taxes, so you cannot simply set up the trust in your will if you wish to avoid estate taxes. The type of trust you set up depends entirely upon whether you are single or married.

Irrevocable Living Trust

If you wish to avoid estate taxes and are single, you will need an irrevocable living trust. This trust removes all of your property from your possession and control and places it in the control of a trustee. To avoid estate taxes, the trustee must be someone other than yourself. However, you can make yourself the first beneficiary of the trust. This means that you can set the rules for payments to be made to you from the trust’s funds to support yourself for the rest of your life. You will also be able to set up instructions for the remaining trust funds after you die. Typically the trust will either continue and give payments to others, or will dissolve and pay the residue to specified recipients.

AB Trust

If you are married, you do not have to surrender your abilities to control your assets until one spouse dies. In an AB trust, you set up an initial revocable living trust for the remainder of your lives. This removes the property from your possession, but leaves you and your spouse as the trustees. Upon one spouse’s death, the trust funds are poured into an irrevocable living trust with an assigned trustee for the remainder of the living spouse’s life. After that, the trust follows the standard irrevocable living trust rules and guidelines.

Trusts and gifting procedures can be very complex. If you are interested in using any of these procedures to remove property from your estate, contact an estate planning attorney to set up a plan that works best for you.

Case Studies: Strategies to Reduce Estate Taxes

Case Study 1: Spousal Gifts 

John and Sarah, a married couple, explore the benefits of unlimited gifting between spouses to reduce estate taxes. They learn about timing requirements and the exception for non-U.S. citizen spouses. They consider this option to maximize their estate planning strategies.

Case Study 2: Gifts to Others

Mark, a wealthy individual, considers gifting as a way to minimize estate taxes. He plans to gift $14,000 annually to each of his children, utilizing the tax-free allowance. Additionally, Mark explores gifting non-monetary assets, such as a summer home in Italy, to reduce his taxable estate effectively.

Case Study 3: Trusts 

John, a single individual, establishes an irrevocable living trust to avoid estate taxes. He appoints a trustee, ensuring his control over the trust’s funds and provisions for his own support. Sarah and John, a married couple, opt for an AB trust, protecting their assets while providing for each other and following irrevocable trust guidelines.