How to Reduce the Estate Tax on What You Leave for Your Heirs
Kohl & Company CPAs
Jul 16, 2020
If your estate is valuable enough to be taxed at your passing, there are a few things you can do to either reduce or even completely eliminate the estate tax on what you leave behind. Keep reading to learn what you can do, or reach out to one of our financial experts.
Despite what many people leave, most estates are not taxed when the owner passes away. Only estates that are valued at $5.5 million or more are taxed before being passed on to the person’s heirs, so less than 1% of the American population has to worry about their heirs not receiving the full value of their estate. Additionally, President Trump’s major tax reform bill includes the goal of eliminating the estate tax entirely by 2024.
Until then, if your estate is valuable enough to be taxed at your passing, there are a few things you can do to either reduce or even completely eliminate the estate tax on what you leave behind. Keep reading to learn what you can do, or reach out to one of our financial experts.
Charitable Contributions
Giving to charity is a well-known tax deduction on your annual tax return, but it will also reduce the size of your estate, thereby reducing or potentially eliminating the estate tax on what’s left behind. Many people choose to give to charities every year throughout their lives. If you’re looking to reduce the size of your estate while doing some good, giving each year is the simplest and most obvious route. However, there are a few other options you can consider.
The first option is to add a charitable lead trust, or CLT, to your will. Instead of willing your funds and assets to an individual, a CLT wills part of a trust to a tax-exempt charity of your choice when you pass away. The assets you include in a CLT are not included when calculating the value of your estate, which means that you can use a CLT to reduce your estate value enough that there will be no tax upon it. The remainder of the trust goes to your heirs.
Another option is adding a charitable remainder trust, or CRT, to your will. Though similar to a CLT, a CRT instead wills a stock or other type of appreciating asset to a charity. During your lifetime, you can continue earning interest and dividends on the assets in the CRT and avoid the capital gains tax. When you pass away, the investment income is donated to your chosen charity, and your estate tax burden is reduced.
Giving Gifts to Your Heirs
Of course, you may wish to pass on the full value of your estate while still reducing or avoiding the inheritance tax for your heirs. The simplest way to do this is to gift them a portion of your estate while you’re still living. Currently, you can give as much as $15,000 a year to any number of individuals without worrying about taxes; this amount can change, however. By giving the maximum amount to each of your heirs each year, you can reduce the value of your estate enough to fall under the threshold for the estate tax while still giving your heirs the full amount of their inheritance.
As an example, let’s say that you have four children. Your estate is currently valued at $6 million. By giving each child $15,000 every year, you can reduce the estate’s value by $60,000 per year. Assuming there are no other changes in the estate’s value, you would reduce your estate’s value to $5.4 million in roughly 9 years, putting it beneath the threshold for estate tax.
Please note that, based on the size and frequency of the gifts, the remainder of your estate may still be subject to an estate tax. We can consult with you on this if you wish. However, even in these cases, the heirs often lose significantly less to the inheritance tax than they would have without the yearly gifts you’ve been giving.
Many individuals also find that they enjoy giving these annual gifts, as they have the opportunity to see their heirs actively enjoy their inheritance. They can see their children take their families on trips with the funds, or send a grandchild to college with assistance from these annual gifts, while also reducing the estate tax on what they leave behind.
Irrevocable Life Insurance Trusts
Did you know that, in many cases, the value of your life insurance plan can be added to your estate’s value? For those with a high-value estate and a high-value insurance plan, this can often—and unexpectedly—push their estate’s value over the $5.5 million threshold and make it subject to estate tax.
If you want to prevent this from happening, one option is to set up an irrevocable life insurance trust. This commits the entirety of your life insurance payout to a trust, which is then transferred to a beneficiary. This does prevent you from making changes to the trust without the beneficiary’s consent; however, it also prevents your life insurance benefits from being included when calculating your estate’s value.
If you want to do this, it’s important to do it as soon as possible. If you pass within three years of establishing an irrevocable trust, the value of your life insurance is still included in your estate.
If you have a high-value estate and are worried about estate tax, contact Kohl & Company today. We’ll work with you and explore all available options to minimize the tax on your estate so that you can leave more behind for your loved ones. Call to schedule an appointment today.