“The estate tax is only for the rich.” Yeah, right.
What if I told you that you were rich! Many Americans are surprised when they add up their assets. Combine retirement accounts, real estate, business ownership, and other assets, and your estate tax liability could be substantial.
Enter: the “death” tax aka the federal tax your loved ones pay from your estate if it is big enough.
There’s an old story about famed New York Yankees owner George Steinbrenner who died in 2010. The late ball club owner, who was worth north of a billion dollars, died in a special year during which the federal estate tax was repealed. The Steinbrenner family avoided a tax bill near $600 million out of pure luck. If you can call passing away ‘luck’!
Don’t count on being so fortunate. The estate tax is back. For 2021, the federal estate tax exemption is $11.7 million per person and $23.4 million for a married couple. That means estates valued at greater than $11.7 million will face a tax bill of up to 40% on assets above the threshold. The $11.7 million federal exemption is a big increase from a few years ago, before the 2017 Tax Cuts and Jobs Act. That increase certainly helps, but the exemption could drop back to just $5 million in 2026 if no changes are made to the current policy guidance.
At the state level, we have good news – there is no Michigan estate tax, but our neighbors in Minnesota and Illinois are not so blessed. Be sure to investigate your state’s law concerning estate taxes.
What’s more, it’s quite likely that the federal death tax will only become more of a factor in the future. Our elected officials in DC keep on spending! Large annual budget deficits and a surging national debt mean higher taxes for many Americans – namely ‘the rich’.
There are steps we can take today to reduce your family’s risk of a significant estate tax burden.
- Spousal exemption: There’s no tax when your spouse inherits all of your assets. Phew. Feel better? Not so fast. You can use this rule, in combination with the federal exemption amount, strategically. Here’s the (legal) trick – leave an amount up to the federal exclusion amount to non-spouse beneficiaries, then the remainder to your spouse. This strategy uses the exemption to the fullest and leaves your family at a lower risk of facing a big estate tax bill when your spouse passes.
- Irrevocable Trust: You can also set up an irrevocable trust to avoid the death tax. However, assets held in a revocable trust are still considered part of the decedent’s estate, so be careful when setting this up. You can work with us at TFC to create an irrevocable trust if your estate approaches the federal exclusion amount.
- Gifting: Take advantage of the annual gift exclusion amount of $15,000 per person per year. The donor generally pays the gift tax on amounts above the exclusion amount. While $15,000 may not sound like much when you have an estate valued well into the millions, several years of gifts to several individuals can add up. Also consider that if you gift money to your grandkids, that money can be invested aggressively and then grow handsomely over the years.
- Charity: You can give as much as you want to charity to reduce your estate. Done properly, you can even send contributions directly from your tax-deferred IRA to a qualifying 501c3 charity to avoid paying tax on your required minimum distributions.
- Insurance: Another tool is a life insurance trust. While life insurance death benefits aren’t subject to income tax, they could be included in the estate if not managed right. An Irrevocable Life Insurance Trust (ILIT) can be created to avoid estate tax liability.
As you can see, there are plenty of tax avoidance strategies you should take, and we can help. Notice we said tax “avoidance”, not tax “evasion”!
That’s a lot to digest! We get it. That’s why TFC is here to help you navigate the estate tax avoidance maze.
Here’s the point
- The estate tax is a tax on your right to transfer property at your death. According to the IRS, it consists of an accounting of everything you own or have certain interests in at the date of death.
- The 2021 federal estate tax is up to 40% for estate values above $11.7 million per person.
- There is no Michigan state death tax.
- There are smart and legal strategies to reduce the estate tax liability your loved ones might face.
Gameplan
You and your spouse worked hard, saved diligently, invested well, and are doing some long-term planning at the kitchen table on a cold Michigan winter night. The evening news features a story on the rising national debt and the likelihood of higher taxes in the future. “The death tax” is uttered as a means to pay for the country’s bills. Perhaps you owned a small business that survived the Great Recession and COVID-19 crash of 2020, and now it’s valued higher than you ever thought possible.
You add up your assets – the business, your house, retirement & brokerage accounts, and it sums to a whopping figure. You realize your family could face the daunted estate tax.
This is a complex scenario! It’s best to come to see us at TFC to help you navigate the rules and take advantage of strategies to limit or even eliminate your family’s death tax liability. We can do it, and it could save you millions of dollars. Strategically using the spousal exemption, gift tax rules, donating to charity, and setting up trusts the right way can ensure your assets are used the way you want (and not the way Uncle Sam wants!)
Photo by Scott Graham on Unsplash