There is a federal estate tax that can come into play if you intend to transfer a significant amount of wealth to your loved ones. This tax carries a 40 percent maximum rate, so it can take a toll on the financial legacy that you are passing along to the next generation.
Fortunately, everyone is not exposed to the estate tax, because there is a relatively large credit or exclusion. The exclusion is the amount that you can pass on before the estate tax would be applicable.
We should point out the fact that there is an unlimited marital estate tax deduction. You can transfer unlimited assets to your spouse in a tax-free manner, but transfers to others are potentially taxable.
In 2016, the federal estate tax exclusion is $5.45 million. Each year the exclusion is adjusted to account for inflation, so it could go up a bit next year.
We practice law in the state of Indiana. Some states in the union have state-level estate taxes, but Indiana is not one of them. However, if you own property in a state is one of the 14 states that has an estate tax, the tax in that state could be applicable. You should certainly do your research and evaluate any exposure that you may have on a state-level. Keep in mind, the state-level exclusions are often considerably lower than the federal estate tax exclusion.
When you create an irrevocable trust, you are surrendering incidents of ownership, because you cannot revoke the trust and take back the assets. As a result, generally speaking, assets that have been conveyed into an irrevocable trust would no longer be part of your taxable estate.
One of these trusts is the grantor retained annuity trust. You could potentially benefit from the utilization of this type of trust if you are in possession of assets that you expect to appreciate considerably over the coming years.
Generation-skipping trusts are also used for tax efficiency purposes. With this type of trust, two generations of the family can benefit from assets in the trust, but there would be just one round of transfer taxes.
Another type of wealth preservation trust is the qualified personal residence trust. This type of trust can facilitate a tax efficient transfer of your home to a beneficiary.
Charitable lead trusts can also provide tax efficiency.
Lifetime Gift Giving
In addition to the federal estate tax, there is also a federal gift tax. These two taxes are unified under the tax code, so the exclusion is a unified exclusion. It applies to gifts that you give while you are living, and it also applies to the estate that will be passed along after you are gone. Since this is a unified exclusion, you would not gain estate tax efficiency if you use a portion of it to give lifetime gifts, because you would be reducing the amount that could be applied to your estate.
However, there is another gift tax exclusion that exists apart from the unified lifetime gift and estate tax exclusion. This is the annual, per person gift tax exclusion. You could use this exclusion to give as much as $14,000 to any number of gift recipients during a calendar year free of taxation.
If your estate is going to be exposed to the estate tax, you could use this annual exclusion to give tax-free gifts to people on your inheritance list over an extended period of time. You would be transferring assets free of taxation, and in the process, you would be reducing the taxable value of your estate.
We should point out the fact that a good amount can be transferred free of taxation when there are married couples involved. If you are married, you and your spouse would be able to give a total of $28,000 to any number of people tax-free during a calendar year. Suppose you have two married children. You could give each couple a total of $56,000 each year tax-free.
The annual exclusion can be used to give direct cash gifts, but you can alternately use this exclusion to fund certain types of trusts. You could also use the annual exclusion to distribute shares in a family limited partnership. This legal structure can facilitate tax efficient transfers between partners.
Attend a Free Seminar
If you would like to obtain more detailed information about estate taxes and other important estate planning matters, attend one of our seminars. The seminars are free to attend, and you can click the following link to see the schedule: Indianapolis, IN Estate Planning Seminars.
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