The idea of estate tax planning might be an entirely foreign concept to you until you start planning your estate. There’s something unique about the process. It holds space for you to reflect on everything you’ve built in your life and the legacy that you’d like to pass on to loved ones. Along with this, you’ll likely start wondering what you can do to protect your estate as much as possible. These are entirely valid feelings to have.
In this guide, we’ll go over estate planning strategies for reducing your estate taxes as much as possible. The best way to protect yourself is through education. If you’re just getting started and aren’t sure what an estate tax is, we also recommend that you read “Estate Tax & Your Estate Plan: What You Need To Know.”
Who Has to Pay Estate Tax?
Technically, it’s the estate itself that has to pay estate tax. Because of this, the question “who is subject to estate tax” is almost a trick. The executor of the estate is responsible for filing and paying any taxes that are due on behalf of the estate.
As of 2021, only estates with a total value of $11.7 million or more must pay the federal estate tax. The federal estate tax is only assessed on the value that exceeds this threshold. According to the Internal Revenue Service (IRS), the fair market value of assets is used, and not the original purchase price or acquisition value.
When the taxes are filed, certain deductions can be made. Example deductions include mortgages, debts, administration costs, and the value of property passed on to surviving spouses or charities.
There are some states in the U.S. that also have estate taxes. If you live in one of these states, you might be facing a double-whammy.
Which States Have an Estate Tax?
Just because your estate won’t be subject to federal estate taxes doesn’t mean that you won’t owe estate taxes at all. There are several U.S. states that levy an estate tax, and their exemptions are much lower. The state-level exemptions are at least half of the federal exemption, and some are as low as $1 million.
Look at the below list to find out if you live in a state with an estate tax, for the tax year 2021:
Connecticut
District of Columbia
Hawaii
Illinois
Maine
Massachusetts
Maryland
New York
Oregon
Minnesota
Rhode Island
Vermont
Washington State
How to Reduce Estate Tax: 5 Tips
What you really might be wondering is how to avoid estate tax altogether. This is possible if the total value of the estate is below the $11.7 million federal exemption, and if you do not live in any of the states we listed above. If you do fall into one or both of these categories, then you’re probably wondering how to reduce estate tax, at the very least.
Here are 5 estate tax planning tips to protect yourself as much as possible:
Spend Down your Assets
This might seem like a no-brainer, but why not lower the total value of your estate to make sure you’re nowhere near the federal threshold for estate taxes? Just be sure not to spend so much that you don’t run out of the funds you need to sustain yourself.
Make Charitable Gifts
If you’re feeling charitable, consider making gifts while you’re still alive. Any gifts you make during your lifetime will help reduce your total estate value, and you’re doing something good for the world! The gift allowance is $15,000 per year. Be careful not to gift more than this amount, or it could lower your estate exemption.
Set Up a Trust
Trusts are beneficial for a number of reasons, with one of them being tax benefits. When you transfer your assets into an irrevocable trust, they are then owned by the trust. The assets belong to the trust itself, and cannot be subject to estate taxes. You won’t lose control of your assets, as you’ll be able to set up provisions on how the assets are distributed and used. Note that revocable trusts don’t offer the same protection. We answer a question about this a bit later.
Tie the Knot
We would never encourage marriage for the sole purpose of tax avoidance. However, if you are in a serious romantic relationship, and marriage is not off the table, consider tying the knot. Federal estate tax laws allow any unused exemption amounts to be applied to the surviving spouse’s exemption. That means that the exemption for married couples could be as much as $23.4 million ($11.7 million each.)
Consider Relocating
If you live in one of the states that impose an estate tax (plus the District of Columbia) it could be time to consider a move. The focus of this article is estate tax planning and doesn’t discuss inheritance taxes. Estate taxes are paid by the state, but inheritance taxes are another category of taxes that heirs and beneficiaries need to worry about. Find out if you live in one of the 6 states that have an inheritance tax.
Common Questions About How to Avoid Estate Tax
At this point, you should have a basic understanding of estate tax implications and how to reduce them. Now, you’re ready for some more advanced topics. Here are some answers to common questions to further help with your estate tax planning.
Does a Living Trust Avoid Estate Taxes?
Unfortunately, a revocable living trust won’t help you avoid estate taxes. The purpose of a revocable trust is to keep your estate out of the probate process upon your passing. You also can’t avoid taxes by trying to shift the percentages to be received by each family member.
Instead, look into setting up an irrevocable trust. These trusts remove assets from your estate and into the trust, providing possible shelter from estate taxes. However, be very careful because this type of trust cannot be changed once it’s executed, nor can you control any of the assets.
A bypass trust allows you to leave some property to your children, and still allows your surviving spouse to use it during their lifetime. That way, your spouse won’t legally own the property and won’t be subject to estate tax.
What Assets are Excluded from Estate Tax?
So far, we’ve alluded to an estate as a general collection of assets. While this is true, it’s important to note that an estate can include a wide variety of assets and property. There are, in fact, some asset types that are excluded (exempt) from estate tax.
Assets exempt from federal estate tax:
Securities that generate interest
Bank accounts not used in connection with business
Insurance proceeds
Assets that are not exempt:
Real property
Tangible personal property
Securities, money markets, brokerage accounts
Which States Have No Estate Tax?
Earlier, we revealed the list of 12 states, plus the District of Columbia, that do not have an estate tax. If you pull out a map of the U.S., you’ll be able to figure out which states don’t have an estate tax.
However, some people seem to want to know specifically which states have no estate tax. Here is the list, as of 2021:
Alabama
Alaska
Arizona
Arkansas
Colorado
Delaware
Florida
Georgia
Idaho
Iowa
Indiana
Kansas
Kentucky
Louisiana
Michigan
Mississippi
Missouri
Montana
Nebraska
Nevada
New Hampshire
New Jersey
New Mexico
North Carolina
North Dakota
Ohio
Oklahoma
Pennsylvania
South Carolina
South Dakota
Tennessee
Texas
Utah
Virginia
West Virginia
Wisconsin
Wyoming
Keep in mind that the above states are specifically excluded from state-level estate taxes. There are some states on this list that do impose inheritance taxes.
What is the Best Way to Avoid Estate Taxes?
If you’re lucky, you can avoid estate taxes altogether. Either you don’t live in one of the states that levy an estate tax, or your estate value is under the $11.7 million threshold (or both!)
Otherwise, the best thing you can do to protect yourself is to stay informed on estate tax rules. This is especially true because the rules can change, especially when a new presidential administration is appointed. Second, part of estate tax planning is in making sure you have a proper estate plan in place. When setting up or updating your estate plan, be sure to avoid these 11 estate planning mistakes. At Trust & Will, our team is there to help you navigate through the process to make it easy, simple, and accessible so you can feel confident that your estate plan will protect you and your family as much as possible.
Is there a question here we didn’t answer? Reach out to us today or Chat with a live member support representative!
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