How to Reduce Estate Taxes
Estate tax is the tax liability imposed at a federal level upon the taxable gross estate of a decedent. While beneficiaries are not responsible for tax against a decedent's estate, it does reduce the value of each successor's inheritance, sometimes substantially. Further, a surviving spouse can incur huge "penalties" simply because her spouse passed away, leaving her full control of an estate equally shared between the two. Some states impose additional state-level inheritance tax, which reduces the value of an inheritance even more.
While estate tax is not typically avoidable, you may be able to reduce estate tax liability through careful planning and by taking advantage of available tax credits. Additionally, the government repeals the estate tax once every ten years, essentially eliminating estate taxes for every estate, regardless of value.
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Instructions
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Claim the unified credit again estate tax, which reduces the total taxable estate for the decedent. The IRS revises the unified credit against estate tax every calendar year, so the amount of the credit varies depending on the year in which a person dies. For example, the total tax credit in 2001 was only $635,000, while the credit increased to $3.5 million in 2009. If the total tax credit for the year matches or exceeds the decedent's total taxable estate, the estate tax liability is eliminated.
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Create a revocable trust for the beneficiaries of the estate prior to the decedent's death, and bequeath the revenue from dividends and interest earned--not the trust itself--to the beneficiaries. Assign the estate or a trusted third party as the trustee. The beneficiaries can enjoy the benefits of receiving quarterly or annual income each year from the revenue earned by the trust while simultaneously avoiding estate taxes.
However, the money the beneficiaries earn is considered taxable income, and any beneficiary who "cashes out" the trust is typically liable for gift taxes.
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Create a credit shelter trust, which allows married couples to take maximum advantage of the unified credit against tax. Both spouses divide their assets equally and create two separate trusts--one in each spouse's name. When one spouse passes away, he bequeaths his trust to his surviving widow, who can apply the full amount of the unified credit against any taxable portion of the trust. The surviving spouse's trust is not considered part of the deceased spouse's estate, so it is not considered taxable for estate tax purposes.
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Mortgage some or all of the equity in any real property owned by the estate, which reduces the total value of the estate. The beneficiaries can use the remainder of the inheritance to pay off the loan in full after the estate transfers the property title, which--when combined with claiming the unified credit--can reduce or even eliminate tax liabilities for many estates.
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Bequeath some or all of the estate to a charitable organization. The IRS exempts most registered 501(c)(3) charities from federal tax liabilities, estate taxes included. By donating some of the estate's assets directly to a qualifying tax-exempt organization, you can reduce or alleviate the estate's tax liabilities.
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Tips & Warnings
If a decedent dies during any year for which the estate tax is repealed, the entire estate is completely exempt from federal estate tax liability. The estate tax is typically repealed on a rotating tax schedule every 10 years--for example, in 1990, 2000 and 2010--although Congress formally determines and announces the rates and repeal years of federal estate taxes, so this is potentially subject to change.
Never attempt to avoid estate taxes by gifting your assets to relatives and friends prior to your passing. Any assets you gift during your lifetime are counted towards your estate's overall value, and your estate will still be liable for estate taxes if your gifted assets and your estate's assets combined exceed the unified credit for that particular year.
