Just as they do during life, taxes affect you even after death. When drafting your estate plan, you should know how taxes will affect your assets once they are passed down. Having a properly structured estate plan will ensure a peaceful transfer of assets and help your beneficiaries avoid a potentially hefty tax liability on your estate.
Federal and State Tax
Due to the federal estate tax exemption, the federal estate tax only applies to estates whose value is more than $11.18 million. This was implicated in 2017 and is expected to continue with adjustments with consideration to inflation. Apart from federal taxes, an estate is also subject to state tax laws. Each state has different state taxes that change yearly. Particularly, New York estate tax ranges from 3.06% to 16%, depending on the size of the estate. The tax threshold for New York is $5.25 million, meaning that if your estate is worth less than that, then you do not owe any taxes to the state. To know exactly how much taxes you will need to pay to the state and federal government, you must know which taxable estate bracket you are in depending on how much the estate is worth.
Inheritance and Gift Tax
Another form of tax that is applied to an estate is inheritance tax. In New York state, there is no inheritance tax. There are only 6 states that have an inheritance tax, which is a tax imposed on certain beneficiaries who received property. As well as not having an inheritance tax, New York also does not have a gift tax. However, gifts made within three years of the decedent’s death are considered to be apart of the estate. Alongside that, although New York does not have a gift tax, the federal government does. If a gift is worth more than $15,000 in 2018, then the federal gift tax applies. With a federal gift tax, there is also a gift tax exemption. This essentially gives you a lifetime exclusion to paying gift tax, worth up to $5,340,000.
There are quite a few estate taxes that one may have to pay, but if planned correctly, there are also ways that one can avoid paying such high rates. If done at least over three years before the decedent’s death and with a value of less than $14,000, giving away assets to beneficiaries as a gift is a good way to prevent paying higher taxes. You can do this yearly and reduce the value of your estate so the federal and state taxes will be lower or nonexistent at the time of your death.
Another good way to reduce estate taxes is by making an irrevocable life insurance trust, or ILIT, as the owner of your life insurance policy. This takes away the value of your insurance from your estate, which overall reduces its value. By reducing the value of your estate, you will be subject to lower tax rates and may possibly avoid paying estate taxes altogether. In doing so, however, you give up any right to make changes to the trust.
Marriage Tax Exemptions
If you are married, you can use both you and your spouse’s estate tax exemptions which will substantially reduce or even eliminate the amount of tax that is owed on behalf of your estate. By splitting your living trust into two separate trusts, when one spouse dies they use their tax exemption, and the same happens when the second spouse dies. This can result in no taxes being owed after both decedent’s deaths.
When inheriting an asset, the value of the property will “step-up” to the value that it is when the decedent dies. This goes hand in hand with capital gains tax, which is a tax paid on the difference between what you paid for an asset and its current value. By applying the step-up basis, the heir pays less capital gains tax on the inherited asset since the value of the property will be valued not at the purchase price, but at the price at which it was inherited.
There is no doubt that a tax liability on your estate can be a heavy financial burden on your heirs. It’s especially important that you understand all the taxes that you may owe on your estate so that there are no surprises when your assets are being transferred and your heirs can have peace of mind. To make sure that this is the case, we highly recommend that you consult with a licensed estate planning attorney, who can give you a proper rundown of what you may owe, and even ways to minimize your estate tax liability.