Tax Planning for Estates

By Brian Burgess, CFP® | May 20, 2024 |

Estate taxes are imposed on the value of a person’s estate upon their passing. These taxes are calculated based on the total value of assets, including real estate, investments, cash, and personal belongings. Tax planning for estates is critical for individuals who want to lessen their tax liabilities and safeguard wealth for their heirs.

There are two categories of estate taxes: federal and state.

Federal estate taxes apply to all estates, but state estate taxes vary depending on where the deceased person resided. Exemption thresholds and rates can vary from state to state.

Optimizing lifetime gifts

One of the effective strategies for reducing estate taxes is maximizing lifetime gifts. By gifting assets during your lifetime, you not only have the chance to see your loved ones enjoy the benefits but also to lessen the tax burden on your estate.

One effective way to make lifetime gifts is by utilizing the annual gift tax exclusion. The IRS allows you to gift a certain amount of money or property to an individual each year without triggering any gift tax. As of 2024, the annual gift tax exclusion is $18,000 per recipient. This exclusion allows you to transfer significant wealth to your beneficiaries over time without incurring any tax consequences.

Another strategy to consider is leveraging the lifetime gift tax exemption. This exemption allows you to gift more money or property without any gift tax. As of 2024, the lifetime gift tax exemption is $13.61 million per individual.

Using trusts for estate planning

Trusts can be a potent tool for reducing estate taxes regarding estate planning. Various types of trusts can aid individuals and families in reducing their tax liability while ensuring a smooth transfer of assets to their heirs.

A marital trust allows a married couple to leave assets to each other without incurring estate taxes. Using unlimited marital deduction, assets transferred to a surviving spouse through a marital trust are not subject to estate taxes. However, while a marital trust can provide tax advantages, it may also limit the control and access to the surviving spouse’s assets. An example of when this may prove helpful is in a second marriage situation, when a couple may want to provide for children from a previous spouse (as beneficiaries of the trust) while still providing a lifetime benefit to their surviving spouse with lifetime income.

A bypass trust (sometimes called a credit shelter trust) can also accompany a marital trust as a second entity created at a spouse’s passing. This trust takes advantage of the decedent’s available lifetime gift exclusion (up to $13.61 million in 2024) to remove assets from the surviving spouse’s estate to pass along to beneficiaries. These trusts can reduce a taxable estate while transferring assets to the next generation. Still, they are administratively complex, and the assets transferred do not receive a step-up basis.

An irrevocable life insurance trust (ILIT) holds life insurance policies outside an individual’s taxable estate. Transferring ownership of the life insurance policy to the ILIT means that the death benefit proceeds can be excluded from the estate, thus reducing potential estate taxes. An ILIT helps create liquidity to pay estate taxes and final expenses or to live on in an irrevocable trust for the benefit of beneficiaries. Trust assets can pay ILIT premiums, and the accounts can be funded annually using exclusion gifting, so long as beneficiaries are informed and waive their right to the deposit when made.

Tax planning for estates: Key strategies

Many individuals and families prioritize reducing estate taxes. By implementing effective strategies, you can minimize the taxable estate and potentially pass on more of your assets to your loved ones.

Here are three key strategies to consider:

#1 Transferring assets to family members

One common strategy is to transfer assets to family members during your lifetime. This can be done through various methods, such as gifting or setting up trusts. Transferring assets can reduce your estate’s overall value, potentially lowering the tax liability. While Federal rules remain consistent, every state has its estate tax exclusions – which may inform what types of wealth transfer strategies to consider.

#2 Gifting to minors and educational expenses

Another strategy is to make gifts to minors or contribute towards their educational expenses. The IRS allows for certain gift tax exemptions, which can be utilized to transfer assets and reduce the taxable estate. By gifting assets to minors or contributing towards their education, you provide for their future and potentially lower your estate tax liability.

#3 Planning the timing and frequency of gifting

Timing and frequency are important considerations when it comes to gifting assets. By strategically planning when and how often you make gifts, you can maximize gift tax exemptions and minimize the impact on your taxable estate. A beneficial way to maximize gifting is to pay tuition costs directly to an educational institution or make medical payments directly to an institution, which are not subject to annual exclusion limits. Another popular strategy is to make gifts at year-end and again in January, which allows for “bunching” two years of annual exclusion gifts into a short window. Consulting with a financial advisor or estate planning professional can help you develop a gifting strategy that aligns with your goals and objectives.

Charitable donations for tax reduction

One option to consider is setting up a charitable trust or making a charitable transfer. This ensures that a portion of your assets is dedicated to philanthropic endeavors. It benefits the charities you choose to support and can also help reduce your taxable estate.

Donating to charity offers various tax advantages. When you make a charitable contribution, you may be eligible for a deduction on your income tax return. Donating appreciated assets such as stocks or real estate can avoid capital gains taxes on the appreciation while still receiving a charitable deduction.

An excellent mechanism for avoiding capital gains is to utilize a Donor-Advised Fund, which allows funding using appreciated securities, provides an immediate tax deduction for the full benefit of the amount contributed to the fund in the year of the contribution, and allows for flexibility to initiate grants out of the account to any 501(c)3 charity at any time in the future.

Integrating philanthropy into your estate plan can be a strategic way to reduce estate taxes. By including charitable giving provisions in your will or trust, you can allocate a portion of your estate to charity, reducing the taxable value of your estate. There are various strategies for incorporating philanthropy into your estate plan, such as establishing a charitable remainder trust or creating a charitable lead trust.

Professional advice for estate tax planning

Navigating the estate tax laws and regulations can be overwhelming. However, with the help of an estate planning attorney, you can gain clarity and peace of mind. They will assist you in understanding the various tax-saving strategies, such as gifting, charitable giving, and establishing trusts, to ensure that your assets are protected and your tax liability is minimized.

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