Thinking about estate taxes is hard. However, creating a financial plan that includes details about what happens to your assets after you pass is very important. People in general are uncomfortable talking about what ultimately happens to everyone, and that is ok. You will have to overcome this feeling, and plan for what will happen to your estate. Your financial plan will need to consider estate taxes and inheritance taxes. We put together this article to answer some questions around this subject. Within, we detail the facts, and other things regarding what to know about estate taxes.
Overview of Estate Taxes
In order to provide details on estate taxes, let’s cover the basics. First and foremost, an estate refers to someone’s total assets, minus all liabilities. Usually an individual will create a will which provides information on how they want their assets to be distribute after they pass. An estate can include items such as a person’s belongings, physical and intangible assets, real property like land, as well as investments and vehicles.
Estate planning refers to the management of someone’s estate. It also includes how these assets will pass on to beneficiaries. A beneficiary is someone who receives assets through an inheritance. Friends, family, and loved ones can all be beneficiaries. You can also have an educational institution, not for profit, or charity be a beneficiary of your estate. You can also split up your estate between many different beneficiaries. For instance, maybe 50% of all assets will be left to your children. The other 50% will be split up between 5 charitable organizations.
Creating a will is a process that should be thought about carefully. You may decide to put some of your assets into a trust, instead of passing ownership directly to the beneficiaries. There are many types of trusts. With many trusts, a trustee is the person or institution (like a bank) that will manage it. A trustee can be an attorney or a bank.
If you have further questions regarding estates, trusts, as well as how to legally form these, you should talk to an accountant, attorney, or a bank that offers trust and estate management services.
What to Know About Estate Taxes
Like many things in life, estates may face taxes. You need to take into consideration estate taxes when creating your financial plan. Creating a solid plan that factors in estate taxes can save your beneficiaries a lot of money in taxes.
An estate tax is determined on a couple different factors. You need to know that any taxes will be transferred from the decedent to their beneficiaries. Taxes are dependent on the state you live in, as well as the size of your estate. Depending on the dollar value, you may not have to pay any taxes on your estate.
Here are some additional things that you should know when you create your estate plan.
Does your state have estate or inheritance taxes?
One thing you need to determine is if the state you live in has estate or inheritance taxes. The terms estate and inheritance taxes are sometimes used interchangeably, they are different. With estate taxes, the amount will be deducted from the total amount of the decedent’s estate. Inheritance taxes are different. With an inheritance tax, beneficiaries will pay this once assets are under their ownership.
There are some other things you should know about these taxes as well. While there is no federal inheritance tax, some states do charge this. There is however a federal estate tax. The good news for some is that federal estate taxes usually only apply to assets over $11.7 million. States do have the ability to charge estate and inheritance taxes, so be sure you know the details about the state in which you live in.
Here is a list of states with either estate or inheritance taxes, or both.
You should understand that this list can change. To be sure where you state stands on inheritance and estate taxes, be sure to check with your local tax authority.
What is the value of your estate?
Once you determine if you have to pay estate or inheritance taxes based on your state, you need to figure out the value of your estate. After this, you can get an estimate of how much tax you will have to pay. Depending on the assets you have, this can be an easy process. However, if you hold a lot of different types of real assets, as well as intangible investments and business holdings, it can be a challenge.
In most cases, your estate will include your home. You will need to check its fair market value. If you currently have several cars or artwork, you will also need to determine the value. Finding out the value of investments is easy considering they are very liquid.
There are other assets you need to consider when determining the value of your estate. Here are some other things that will impact your estate value, and possibly the amount of taxes you will end up paying.
- Life insurance policy
- Properties under joint tenancy or properties that you personally own
- Value of survivorship benefits
- Holdings of an LLC
Once you determine the value of all your assets, add it all up. Next, subtract all outstanding debt you have. This can include a mortgage, home equity loan, home equity line of credit, student debt, and vehicle loans. The number you arrive at will be a rough estimate of the value of your estate.
Reduce Your Estate Taxes
Something you should know about estate taxes is that there are ways to reduce them. Here we will list a couple methods that can help you and your beneficiaries save on estate and inheritance taxes.
The first way is by gifting or making charitable donations. When you give a gift to someone, whether it is stocks, cash, or other assets, you remove these items from your taxable estate without paying taxes. The recipient will have to pay taxes though. Also, any gifts you give to charity may have an exclusion from an estate tax. You may want to create a CLT, or charitable lead trust, which allows a charity to receive an annuity from your estate for a set number of years.
Another type of trust you may want to form is a qualified personal residence trust, or QPRT. This is where you put your home in a trust, removing it from your taxable estate. A QPRT is when a person transfers their personal residence into a trust. They then continue to live in the house for a period of years. They still get to use the property to live in, however it reduces the current value of their estate.
Trusts can be hard to understand unless you are an expert. Plus, there are many legalities associated with them. You should probably work with a trust officer or advisor to determine the best way to proceed.
Things to Know About Estate Taxes – Summary
Estates can be very complicated. You may find it hard to create an estate plan considering it involves thinking about yourself passing. However, financial advisors, accountants, and attorneys can help you throughout this process.
One thing to know is that you may have to pay an estate tax. Also, beneficiaries of your estate may also have to pay an inheritance tax. You should determine the types of taxes your state charges, as well as the value of your estate. It also helps to know ways that you can reduce possible estate taxes, and inheritance taxes your beneficiaries may have to pay.