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The Ins and Outs of Estate Tax

December 01, 2021

Throughout our lives, we are responsible for managing and paying our taxes and attempt to reduce them whenever possible. But what about taxes on our estate that occur after we’ve passed? What is the best way to prevent those taxes from spiraling out of control, arriving unexpectedly, or being too overwhelming for your heirs to manage?

The answer will always depend on the value or size of your estate and it’s best to discuss it with a professional estate planning attorney who can look over your specific situation. In the mean time, this article covers the ins and outs of estate taxes, breaks down the difference between estate and inheritance tax, and shows you how to minimize your estate taxes while you’re still alive and well.

Estate Tax and Inheritance Tax

By simple definition, estate tax is a levy that is imposed on the entire estate after the owner’s death, determined by the value of the estate. Not every state in the United States imposes thesetaxes, and it’s very likely that you do not have to pay them.

An inheritance tax is actually paid by your heirs, after your passing, on the value of the inheritance for certain assets. Unlike estate taxes, inheritance tax only applies to the size of the gift received or inherited, and is not assigned to the value of the deceased's entire estate.

While estate and inheritance taxes seem very similar on paper, the main difference comes down to state and federal regulation. In the case of estate taxes, let’s say for example that you live in the state of Colorado. Colorado estate tax laws do not exist, but as of 2021, if your estate is valued at $11.7 million or higher, your estate will not be exempt from federal taxation, therefore you would be subjected to pay estate tax.

In the case of inheritance tax, let’s say your heir lives in the state of California, but you reside in Kentucky or Pennsylvania (two of the six states where inheritance tax is collected.) Your heir’s inheritance would be subjected to the tax your state enforces. In other words, regardless of what state your heir lives in, the law is defined by which state you live in so you will want to be well aware of this when preparing your estate documents.

Before reaching a point of panic, remember that the vast majority of estates are too small to be charged estate taxes ($11.7 million in 2021, increasing to $12.06 million in 2022.) Further, only six states in the entire United States enforce inheritance tax, so chances are high you are not subjected to them. That said, it is always wise to work with a professional tax attorney who can help you navigate your particular situation so you are armed with all the information that applies to your estate.

What Assets Are Subject to Estate Taxes?

So now you might be asking yourself what specific assets make up your taxable estate? This can seem subjective and cause for manipulation or personal interpretation, but it’s actually quite clearly defined by state and federal governments in order to prevent tax fraud or avoidance.

Funds you have in your bank account, stocks, bonds, or mutual funds you own, real estate, cars, collectibles, and even coins are assets that are included in your taxable estate. Even partnerships, business interests, and assets held in joint tenancy fall into this category.

To avoid these items from falling victim to a probate tax, people commonly hold them in a Transfer on Death account. A transfer on death (or TOD) account is a series of documents that designate beneficiaries who you would like to receive your assets after your death. This document can prevent your assets from going through probate court or being subjected to probate taxes, a tax that can arrive unexpectedly after your passing. Your heirs would be responsible for this tax, so to avoid this burden, make sure you have a TOD set up right away.

A professional estate tax attorney can help you construct and refine a transfer on death, as well as help you go through your assets to determine what adds to the value of your estate and will be subjected to relevant taxes.

How Can I Minimize My Estate Taxes?

There is really only one good way to reduce your estate tax liability: get assets out of your name before your death. If your estate is high enough in value, you can create special trust accounts to achieve this. You can also convert your retirement accounts to a Roth IRA.

Another way to minimize your estate tax liability is to start giving your family your assets. Anyone person may be gifted a tax-free asset that is valued at $15,000 or less (or up to $30,000 if you’re married and you and your spouse file your taxes jointly.) Another option is to make a charitable contribution through a trust. The advantage to a charitable trust is these funds are tax-exempt, providing the charity every penny of the funds you’ve awarded them. This is a great option if you do not have any children or heirs, or are looking to pay it forward in a really big way.

Estate Plan Today, Enjoy Retirement for the Rest of Your Days

Truth is, no one wants to start planning for their death and giving thought to their estate tax liabilities. However, getting out in front of it by working with an estate planning attorney now will allow you to enjoy the rest of your life with peace of mind. Knowing your assets are outlined, assigned, and not subject to certain tax law criteria will allow you to rest easy knowing that your funds and estate are in good hands and that your heirs won’t be hit with unsuspected tax burdens or surprises.

Start estate planning today so that you can enjoy your years of retirement tomorrow and beyond!

For tips and information regarding retirement plans, contact us.

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About The Author

Kyle Rutten is the digital content manager for Brestel Bucar, a law firm specializingin estate planning and mediation. He has written extensively on elder law, probate, estate taxes, and estate planning. Kyle is passionate about general financial literacy and believes strongly that it is becoming as important as nutrition for modern people.

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