A California resident, Rosa Dominguez, won the lottery twice in the same week. Only 19 years old, Dominguez purchased a $5 scratch-off lottery ticket and won $555,555. A few days later, she purchased another 5 scratch-off lottery ticket, this time winning $100,000. Although more than $600,000 is a lot less than the current Powerball jackpot, it still reminds us of the need to plan for estate taxes.
Lottery winnings can affect estate taxes
The Powerball lottery, played in 44 States, Washington D.C., Puerto Rico, and the US Virgin Islands, often has a multi-million dollar cash payout. While the odds are stacked high against winning , ordinary people still have the opportunity to win extraordinary sums of money through this lottery and many others.
As many dream and plan about what to do with all those winnings, should they be so lucky, few seriously consider whether winning the Powerball will have any estate planning implications. If Powerball winners elect to take the lump sum payment, income taxes will first be deducted, leaving substantially less money. So, what does this mean for the estate taxes of these lucky winners?
Estate taxes are assessed on lottery winnings
If someone were to die in a fatal automobile accident just days after winning the lottery, all of those winnings would be subject to estate taxes. With the current federal estate tax rate of 40%, a winner’s heirs would be forced to pay 40% of the new family fortune. Luckily, there is a federal estate tax exemption that can significantly reduce the amount of taxes assessed.
How does the federal estate tax exemption work?
The federal estate tax exemption provides that an estate with a value below the exemption amount can be passed on tax-free. As of 2018, the exemption amount is $11.2 million per person. This estate tax exemption is “portable,” which means that the surviving spouse of a decedent can benefit from any unused portion of their deceased spouse’s exemption. The unused portion of the exemption is then combined with the surviving spouse’s own exemption.
What happens if your estate exceeds the annual exclusion?
Although most estates do not exceed the $11.2 million exclusion amount, there are certainly some estates that do. If your estate exceeds the exemption amount, an estate tax of 40 percent of the excess amount will be imposed. If you are married, though, you can take advantage of the unlimited marital deduction that is available for spouses. There are also a variety of other ways that you can avoid estate taxes through the use of estate planning tools.
Using the marital deduction to eliminate estate taxes
Married couples can give a gift of an unlimited amount to each other. The value of the property gifted to the surviving spouse is subtracted from the deceased spouse’s estate. Because all assets go to the surviving spouse, there are no estate taxes imposed. A married couple can in effect protect $22.4 million from federal estate and gift taxes in 2018. This is most commonly referred to as the lifetime credit.
What is the “generation skipping” tax
The “generation skipping” tax is yet another type of estate tax you should be familiar with. This is a tax assessed on any assets passed on to a generation that is two or more levels below the decedent. In other words, when you leave property to your grandchildren, as opposed to your children, the IRS will assess the generation skipping tax. This particular tax also applies to a transfer of property to someone who is unrelated to you and who is 37 ½ years or more younger than you.
Generation-skipping trusts can be useful
The goal of a General Skipping Trust is to minimize or avoid estate taxes on transfers made to subsequent generations. This is accomplished by holding the assets in trust and distributing the funds in a pre-defined way, to each successive generation. In this way, the entire amount of the trust is protected from estate taxes with each passing generation. A common misconception is that Generation Skipping Trusts are only for wealthy families, but most families can benefit from this type of estate planning.
Download our FREE estate planning checklist today! If you have questions regarding estate taxes or any other estate planning matters, please contact us at the Northern California Center for Estate Planning and Elder Law for a consultation. You can contact us either online or by calling us at (916) 437-3500. We are here to help!