For over a century, the United States Government has taxed assets that remain after a person’s death. However, the current estate planning laws give individual’s an exemption limit that allows them to pass a portion of their assets down to their heirs tax-free.
How the government taxes individual estates has changed dramatically over the last two decades. For example, twenty years ago, the federal estate tax exemption limit for married couples was $1,350,00. Currently, the federal estate tax exemption for married couples is $23,160,000. Because of this large increase, most people assume they are safe from estate taxes altogether. However, just because many will be under the federal tax exemption limit does not necessarily mean that they will be under their individual state tax exemption.
Many states—including the District of Columbia and Maryland—have their own estate or inheritance taxes on assets that residents of these states pass down to their family or friends. In most cases, the state estate tax exemption limits are much lower than those of the federal government. Thus, if you do not start planning your estate today, you and your heirs could end up paying additional taxes later.
Defining State Estate and Inheritance Taxes
Currently, seventeen states and the District of Columbia have one or a combination of an estate and inheritance tax.
- The estate tax is a liability paid at death on the total estate before distribution to its heirs.
- The inheritance tax is the responsibility of the beneficiary after receipt of the inherited property with the tax rate dependent on the familial distance from the decedent.
As both estate and inheritance state taxes have a much lower exemption rate than federal estate taxes, residents must account for these additional taxes in their individualized estate plans.
How to Minimize Estate and Inheritance Taxes
If your state has its own estate or inheritance taxes and your individual estate is valued at more than $11,580,000 or $23,160,000 for married couples, you will likely have to pay estate taxes at both the state and federal level. However, if your estate is valued below the federal level, there are multiple estate planning strategies you can employ to reduce your total state estate or inheritance tax. The most common of these strategies are:
Immediate Asset Spending
One of the easiest ways to minimize your estate tax liability is to spend or transfer some of your assets while you are still alive. Those with taxable assets can accomplish this goal through:
- Spending assets outright. The fewer assets available in your estate upon death, the less the tax liabilities for your estate and your executor.
- Gifting assets to family members or charities. You are permitted to gift up to $15,000 per donor and per recipient tax-free each year (not including charities). In addition, if you accelerate any charitable gifting, you can take advantage of the itemized deduction today while also reducing your taxable estate in the future.
Trust Planning
Trust planning is another common way to decrease state estate or inheritance tax liability. The simplest way a trust plan is to equalize the assets within both spouse’s estates. Equalizing estates is extremely important as most states do not allow one spouse to utilize the entire estate tax exemption and instead, the exemption is split equally between partners. Ways to reduce estate taxes through trust planning include:
- Shifting of Assets — It is common for spousal retirement accounts to varying in value with contributions/withdrawals and market fluctuation, leading one spouse to likely accumulate more assets than the other, resulting in a higher potential for a taxable estate. While you cannot change the ownership of retirement assets, you are able to modify the ownership of brokerage assets. You can shift these brokerage assets between spouses tax-free by transferring funds from an account under one spouse’s name to an account under the other spouse’s name. This will equalize the assets in each individual’s estate.
For example, say a married couple is living in a state with a $5,000,000 per person estate tax exemption and one spouse has $7,000,000 in assets while the other spouse only has $1,000,000 in assets. Taking this scenario, the couple would have to pay estate taxes on $2,000,000 of their assets. However, using the planning above, the couple would be able to shift $3,000,000 from one spouse account to the other. Using trust planning, the imaginary couple would each have $4,000,000 in assets meaning that although they still have the same combined value in assets as before, they would not owe any state estate taxes.
ABC Trusts
One of the more complex but effective ways to reduce your estate tax liability is to have an attorney create an ABC trust. ABC trusts work to lower the estate tax burden by dividing one’s assets into two parts:
- Assets equal to the federal (or state) exemption limit
- All other assets passing outside the person’s estate
ABC trusts are more expensive to create compared to other common ways to reduce one’s state estate tax liability. However, ABC trusts are extremely useful to lower the tax burden on both state and federal estate taxes. The reason for this is that they ensure that each person maximizes their estate tax exemption amounts.
Relocation
Establishing residency in a different state can benefit your estate tax situation in more than one way. For example, moving to a different state after retirement not only helps you save on property and income tax. However, it can also minimize your state estate and inheritance taxes.
Contact Our DC Law Office for More Information
Finally, for more on how planning ahead can minimize your state estate taxes, contact us at 202-803-5676. You can also directly schedule a consultation with one of our skilled attorneys. Additionally, for general information regarding estate planning, check out our blog.