Estate Taxes: Planning Now to Avoid Taxes Later

Despite the controversy over estate taxes in recent years, many people really don’t know much about these much-maligned taxes levied on inheritances. Currently, the federal estate tax only affects those estates of $5 million or more. The intention was to only tax the very wealthiest estates, rather than affect the inheritance of more modest family fortunes.

Avoid Estate Tax

Unfortunately, the legislation has not always kept up with inflation, and the tax has been criticized for hurting “regular” families — to the tune of 35% of the entire estate. However, there are several ways to avoid the inheritance tax and still honor your intentions for your money.

1. Leave Property to Your Spouse

Leaving your property to your spouse exempts the estate from the tax — no matter how big your estate is. Provided your spouse is a U.S. citizen, he or she can inherit everything without paying a dime to Uncle Sam. This is also true if you want to gift your estate to your spouse before your death. Any amount of money can be given to a spouse (who is a U.S. citizen) at any time without taxes. If you are married to a non-citizen, you can gift your spouse up to $134,000 per year before taxes are levied.

2. Leave Estate to Charity

You may also leave your entire estate to a tax-exempt charity with no penalties. This is obviously less common, but for those with no family, it can be a wonderful way to leave a legacy.

3. Give Tax-Free Gifts

You may give tax-free gifts while you are alive that will reduce the eventual size of your estate. You may give up to $13,000 per year per individual without paying any taxes. In addition, you do not have to pay taxes on money you pay for another individual’s tuition or medical bills. This is an elegant solution because it allows you to enjoy the recipients’ reactions to your gifts and avoid costly taxes.

4. Use a Trust

There are several types of trusts that will protect your estate from taxes. An AB Trust allows a spouse to leave property to the children, but allow the surviving spouse to use that property for the remainder of his or her life. A Qualified Terminable Interest Property (QTIP) Trust gives spouses the ability to postpone paying estate taxes until the second spouse passes away. Finally, a Life Insurance Trust is set up so that you will take the proceeds of the insurance out of your estate, making it tax-exempt.

It may be easy to think that you do not have to worry about estate taxes. The $5 million exemption limit certainly seems fairly high. However, that limit is due to expire in 2013, when it will return to a limit of $1 million unless the government makes changes to the existing laws. Even if you don’t foresee needing to worry about your estate for many years to come, it’s better to plan ahead now and not leave your heirs scrambling later.

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