Whether wealthy or not, there are steps that everyone can take to reduce estate tax obligations. Proper estate planning can greatly reduce and potentially remove tax obligations.
There are three examples that most taxpayers can use on their estates.
1. Gift wisely
Some assets are best gifted during one’s life, some after. Gifting is an important step towards reducing the estate’s tax obligations, as it lowers the estate’s overall value. This is particularly important for estates that are at or above the estate tax threshold. For federal estate taxes, this number is set at $11.58 million for 2020.
Each individual taxpayer can gift up to $15,000 per person per year. This means a married couple could gift another individual a total of $30,000 every year. However, gift assets that appreciate with care. Stockholdings and real estate assets are two examples that can gain value. When the owner dies, the asset is given a step-up in basis. This means that instead of getting taxed for the full appreciation, the individual who receives this asset is only taxed in the amount that changes from the owner’s death to the time they choose to sell the asset.
2. Convert retirement assets
A failure to properly account for retirement assets can result in a large tax bill for the estate. A traditional IRA or 401(k) comes with income tax obligations. You can avoid this additional tax bill by converting these accounts to Roth accounts. This will result in a distribution to beneficiaries without the income tax obligation.
3. Get a trust
Trusts are legal tools that can serve two goals: protect assets from creditors (including the Internal Revenue Service) and beneficiaries who may not be money savvy. The language used to create the trust outline the goals. A failure to include a provision or a poorly written provision can defeat the goal of the trust. You can mitigate this risk by seeking experienced legal counsel to draft these documents on your behalf.
The trust can also include instructions on how beneficiaries can use the funds. This is helpful if you have a child, grandchild or another loved one who you fear may not use the money wisely.