Americans are subject to paying a tax on estates and inheritances depending on the state where the person lived upon death and the maybe federal government. The tax rate on estates and inheritances varies depending on the total value of the estate. The federal tax law requires an estate tax from anyone passing on estate’s worth over $11.7 million at the present time.
Besides these taxes, each state may tax estate and inheritances as well. The exemption amount is less than the federal exemption in all states with an estate or inheritance tax. Most states tax estates and inheritances at a sliding scale rate or as determined by the relationship of the person who died to the beneficiary.
What is Estate Tax?
The estate tax is a type of tax levied on the estate before passing it to beneficiaries. Federal Estates are subject to tax based on their values, with a top bracket of 40% for amounts in excess of $11.7 million in 2021. This tax aims to prevent large concentrations of wealth or inherited wealth in a single person.
How it Works and How to Make Sure you Don’t get Caught by Surprise.
The tax is assessed on the net value of an estate. The current exemption for federal estate tax is $11.7 million in 2021, which may increase every year with inflation. This means that individuals with estates under $11.7 million are not subject to this tax. So, if your total assets add up to $11 million, you will be free from paying the federal estate tax.
But if your estate is worth $11.7 million, you will pay an estate tax of 40% on the amount above the exemption limit. This means that you will have to pay a 40% tax for every dollar above the exemption.
However, there are a few exceptions as to whether your assets could be counted in determining the amount of estate tax you owe. For example, if you have substantial assets in life insurance, retirement accounts, or property passing to your spouse, these assets may not be subject to taxation. Your heirs may also receive a deduction that will eliminate any estate taxes on the assets.
How to Avoid or Reduce Federal Estate Taxes
- Spreading Your Assets
Spreading your assets in the form of life insurance, joint tenancy with right of survivorship in real estate, joint bank accounts, joint ownership of IRAs, and other retirement plans can reduce or eliminate federal estate taxes. Also, you can transfer stock options in your business to your spouse or heirs by your will or revocable trust.
- Charitable Donations
Many people leave money in their will or trust to churches, schools, hospitals, and other qualified charitable organizations. Your heirs get an income tax deduction for charitable donations made from your estate. Gifts of appreciated assets also reduce the value of your estate. Keep a detailed list of assets in your portfolio, including stock ticker symbols and purchase date and original cost.
- Create a Family Limited Partnership
Avoiding estate taxes is simple if you plan. Establish a family limited partnership or family limited liability company to hold title to family assets, including real estate, stocks, bonds, and other property. These entities are entirely separate from your estate. They own the assets within them, not you or your spouse. When you transfer the assets into these entities, they become the new owners of those assets.
- Put Your Residence into a Qualified Personal Residence Trust
This is a trust that you create in your lifetime and place your home in. You transfer ownership of the home to the trust but retain the right to live there. In the event of the termination of the trust as stated in the trust document, the home’s value passes to the trust beneficiaries without subjecting them to federal estate taxes. This is a good option if your home is worth more than the applicable federal estate tax exemption amount however the trust must terminate prior to your death.
What Is Inheritance Tax?
To help taxes, individual states require an inheritance tax. This taxes the person receiving the inheritance. States have different policies on what they think is “fair” to tax, but many states charge an inheritance tax between 0-18% depending on the relationship of the person who died to the beneficiary. Inheritance taxes are considered income taxes because you are receiving money, not just wealth.
Inheritance tax is triggered once the executor has divided assets among beneficiaries. Each beneficiary must pay their taxes, which are calculated separately. For example, a state may impose a 5% inheritance tax on estates worth more than $10 million. If a friend lives with you, $15 million inheritance, taxes are only payable on $5 million of the $15 million left behind by your friend. Therefore, you will pay $ 250,000.
Exemptions from Inheritance Tax
Inheritance tax exemptions or reductions are available depending on your relationship to the decedent. It is common for heirs to properties with no family connection to the decedent to pay higher tax rates.
However, when a spouse inherits property from another spouse, they are usually exempt from paying taxes. The same exemption may apply to dependent children and other dependents, though sometimes only an inherited part of the property qualifies.
Tax-Avoidance Tips for Inheritance
- Trust:One way to decrease the taxes on inheritance is by putting everything into a trust. Any property or money that is put into a trust will not be taxed. This will allow the beneficiary of the trust to enjoy the property without paying taxes.
- Donating:Some techniques to help protect your inheritance from the taxes that may be collected include donating some of the money to charity or a school for children of low-income families.
- Alternate valuation date:Inheritance taxes can be a financially devastating burden on family inheritances. An effective way to protect against this is by using a “discounted alternate valuation date”, which offers a different set of values to the IRS for the valuation of the inheritance.
The estate and inheritance tax applies to only very few people in the United States, but if you are one of those people, there is a lot that can be done to lower or eliminate estate and inheritance taxes. The Tarta Law serves clients in Midland Park, Ridgewood, Glen Rock, Wyckoff, Saddle River, Upper Saddle River, Ramsey, Paramus, Mahwah, Pines Lake, Wayne, Woodcliff Lake, Park Ridge, Waldwick, HoHoKus, Park Ridge, Allendale and Franklin Lakes, among other municipalities in New Jersey. If you or your loved ones will be subject to paying an estate or inheritance tax, call us today at 201-444-8448 to learn more about how we can help.