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Ways The Rich Can Avoid Estate Tax

Ways The Rich Can Avoid Estate Tax

The idea of an estate tax, or inheritance tax, as it is sometimes called, strikes fear in many Americans. It is understandable, although the truth is that most people will never come across it. Indeed, the federal property tax has an extremely high exemption value. In short, if your assets are worth less than the current year's exemption, you won't have to pay federal tax. However, you have to deal with state taxes in some parts of the country. For real estate assistance, consider working with a financial advisor.


What is the estate tax?

The estate tax is a federal law requiring properties worth more than the current year's exemption to pay a certain amount of tax for any amount over the exemption. For 2021 (paid in 2022), the federal property tax exemption is $11.7 million. If your assets are worth less than they were worth at the time of death, your estate owes the IRS nothing. In 2020, the estate tax exemption was fixed at $11.58 million.

Waiver of the $11.7 million above means estates can deduct that amount from the total if it is worth more. Therefore, if an estate is worth $12.3 million, you will only pay $600,000 in estate tax above the exemption.

Most states in America do not have an estate tax, but some do. Specifically, properties owned by residents of Connecticut, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and Washington D.C. may be subject to property taxes. Exemption amounts vary by state.

Additionally, some states have inheritance taxes that owners may be required to pay. These states include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Maryland is the only state that has an estate and inheritance tax.


How to avoid property taxes

Unsurprisingly, most people aren't exactly happy with the prospect of paying inheritance tax after they die. In turn, there are some strategies you can use to minimize what you owe or avoid estate tax altogether. Here are some ways to avoid property tax if your estate is susceptible to debt.


Give family gifts.

One way to circumvent inheritance tax is to give some of your estates to family members through donations. For the 2021 tax year, you can offer anyone up to $15,000 excluding taxes (or up to $30,000 if you're married filing together). You can give up to $11.7 million of your assets during your lifetime before paying gift tax.

There is no limit to the number of people you can give gifts to in a year. So, if your net worth is $17 million, you can gradually transfer your assets to your loved ones until the net worth is less than (or equal to) $11.7 million.

Please note that the $11.4 million limits apply to both gift and estate taxes.


Create an irrevocable life insurance fund.

If you don't desire for your family members to struggle financially after your death, purchasing life insurance is good. Income from life insurance is generally not taxable. But after your death, they can be part of your taxable wealth.

To avoid taxation of life insurance income, you can create an irrevocable life insurance fund. You need to build trust and transfer ownership to someone else. The trust is irrevocable because you cannot make changes in the future without the trustee's consent.

The death benefits would not be part of your assets by transferring your life insurance policy. However, it is best to do it sooner rather than later. If you die within three years of making the transfer, your life insurance earnings will still be considered part of your taxable assets.


Make charitable donations.

Another way to avoid estate tax is to transfer part of your estate to a charity through a trust. Charitable Lead Trusts (CLT) and Charitable Remainder Trusts (CRT) are two types of charitable funds.

If you have a CLT, some of your trust assets will go to a non-taxable charity. By donating to charity, you will reduce the value of your property and receive additional tax benefits. Whatever is left in the trust will pass to your beneficiaries after your death (or after a predetermined period).

Alternatively, if you own a CRT, you can transfer a stake or other valuable asset to an irrevocable trust. During your lifetime, you can earn money from this resource. And when you die, your investment earnings will go to charity. You will avoid capital gains tax and reduce the property tax burden in this process. In addition, you will benefit from a tax deduction.


Start a family-limited partnership.

If there are family businesses or assets (such as property) that you want your children to own when you are gone, you can create a limited partnership. This usually involves building a partnership and then establishing heirs and limited partners.

As the general partner, you will still be in charge. But your partners (whether your children or another relative) will either have a stake in your business or own some of your assets. As a result, your property size will be smaller.


Finance a qualified personal residence trust.

Another way to reduce the value of a property subject to inheritance tax is to fund a qualified personal residence trust. With a qualified personal residence trust, you transfer ownership of your home to a trust. During the trust, you can continue to live in your rent-free accommodation. After this period, your heirs can take back your property.

With a qualified personal residence trust, you can freeze the market value of your primary residence and/or vacation home and avoid paying gift tax (provided you haven't exceeded your lifetime limit for taxable gifts). It will also instantly reduce the size of your property.

Unfortunately, your house will still be part of your property if you die before your trust is exhausted. And while you can build trust in your home with a mortgage, it's easier to create a qualified personal residence trust for a rental property.


Bottom Line

Very few people will have to worry about estate/inheritance/property tax. But suppose you're inheriting millions of dollars and worried about inheritance tax. In that case, you can circumvent this problem and reduce your tax burden by planning and making the most of some of the tax loopholes for the wealthy.

A financial advisor can help you optimize your estate plan to be sure your family will be well taken care of when you die. 


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