A primary concern for many clients, with regard to estate planning, is inheritance taxes. Indeed, for most people the primary goal of estate planning is to reduce or eliminate taxes as much as possible. California inheritance taxes, also referred to as estate taxes, are no longer imposed. However, in 2016, the federal government still imposes estate taxes at a tune of 40%. The good news is, there are tax exemptions that exclude most people’s estates from paying inheritance taxes. So, the question remains: do you need an inheritance tax planning trust?
California inheritance taxes have been eliminated
As of January 1, 2005, California no longer imposes a separate inheritance tax at the state level. Therefore, the only inheritance tax California residents need to be concerned with is on the federal level. Currently there are 17 states who still impose estate tax on the state level: Connecticut, Delaware, District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, and Vermont. People in those states, probably need to consider an inheritance tax planning trust.
How does the federal estate tax exemption work?
The federal estate tax exemption allows an estate with a value below the exemption amount to be passed on to heirs tax-free. Again, the exemption amount in 2016 is $5.45 million. It is scheduled to increase to $5.49 million in 2017. However, changes to the estate tax law are expected in 2017 due to the election of Donald Trump as President.
The federal estate tax exemption is “portable,” meaning that the surviving spouse of a decedent can take advantage of any unused portion of their deceased spouse’s exemption. That unused portion is combined with the surviving spouse’s own exemption. For example, if only $1,000,000 of the wife’s $5,450,000 exemption is used, then the surviving husband can elect to add his wife’s remaining $4,450,000 exemption to his own. This will allow him to pass on up to $9,900,000, tax free.
What if your estate exceeds the annual exemption amount?
Although most estates do not exceed the $5.45 million exemption amount, there are obviously some estate that will. If your estate exceeds the exemption amount, an estate tax of 40 percent will be imposed only on the excess amount. However, if you are married, you can take advantage of the unlimited marital deduction available to spouses. There are also other ways that you can avoid estate taxes through the use of estate planning tools, such as an inheritance tax planning trust.
Using the marital deduction to eliminate estate taxes
Married couples can give an unlimited gift to each other that will be untaxed. But, ultimately, 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 essentially protect $10.9 million from federal estate and gift taxes. This is most commonly referred to as the lifetime credit.
Considering the “generation skipping” tax
The “generation skipping” tax is another type of inheritance tax that you should be familiar with. This tax is assessed on any assets passed on to a generation that is two or more levels below the decedent. Put another way, if you leave property to your grandchildren, instead of to your children, the IRS will assess the generation skipping tax. This special tax also applies to transfers 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 valuable
The purpose of a General Skipping Trust is to minimize or avoid inheritance taxes on transfers made to subsequent generations. This can be accomplished by holding the assets in trust and distributing the funds in a pre-determined way, to each succeeding generation. Doing it this way, the entire amount of the trust will be protected from inheritance taxes with each passing generation. A common misconception is that the Generation Skipping Trust is only helpful to wealthy families. That is not the case. In fact, most families can benefit from this type of inheritance tax planning trust.
Making gifts instead of inheritances
Another strategy in inheritance tax planning is transferring property to your grandchildren or other heirs as gifts instead of inheritances. This will reduce the size of your estate, as well as reduce the amount of taxes imposed on your estate upon your death. You can make an outright gift, pay healthcare or educational expenses, or transfer the money into an inheritance tax planning trust.
Join us for a FREE seminar! If you have questions regarding an inheritance tax planning trust, or any other estate planning needs, contact the Northern California Center for Estate Planning and Elder Law for a consultation, either online or by calling us at (916) 437-3500.