How to Avoid Inheritance Tax
Determine what is taxable., Identify exclusions., Calculate your gross estate., Subtract deductions., Identify taxable gifts., Determine if your estate is taxable., Identify your Tentative Estate Tax., Deduct credits., Recognize your estate tax...
Step-by-Step Guide
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Step 1: Determine what is taxable.
Estate taxes and inheritance taxes are very similar and both seek to minimize the transfer of wealth after death.
If you understand how to calculate these taxes, you will also be able to understand how to avoid them.
Taxable property includes cash, securities, real estate, insurance, trusts, annuities, and business interests.A more in depth description of taxable items is included in the Internal Revenue Service's (IRS) Form 706, which is the Estate Tax Return.Look at Form 706 Instructions as well for help understanding what is considered taxable., Some items are not considered taxable for the purposes of calculating your gross estate.
Generally, you will not be taxed for items owned solely by your spouse or other individuals.
Life estates given to you in which title passed upon your death will not be included either.Also, you will not include charitable conservation easements, social security benefits, and workers' compensation death benefits., The gross estate, which will be calculated as of the date of death, includes everything you own or have certain interests in that is taxable.
Do not include any exclusionary property in this calculation.
When you calculate the value of these things, you will use the fair market value (FMV), not what you paid for it or what its' value was when you acquired it.
The FMV is the price at which something would sell between a willing buyer and willing seller if neither were under compulsion and both had a good understanding of the relevant facts.For example, let's assume that when you die you have $2 million in cash, $4 million in real estate, and $3 million in annuities.
You also had a life estate in a home that was passed to your spouse at your death as well as workers' compensation death benefits that went to your child in the amount of $750,000.
In this scenario, your gross estate would equal $9 million. , You are able to reduce your tax liability by subtracting allowable deductions from your gross estate.
When you do this, the remaining amount is considered your Taxable Estate.
In general you will be able to deduct the marital deduction, charitable deductions, mortgages and debts, administration expenses of the estate, and losses during estate administration.For example, let's assume that when you die you are able to take deductions in the amount of $2 million based on qualifying mortgages and the marital deduction.
Based on the example so far, your Taxable Estate (Gross Estate
- Deductions) equals $7 million ($9 million
- $2 million). , Under federal law, lifetime gifts are reported and any gift tax you may owe is calculated annually.
When you die, those gifts are added back into your estate for the purposes of calculating estate tax.
This results in you possibly paying taxes on the wealth that you give away, as well as the wealth you have kept and accumulated.
Taxable gifts are generally gifts made after 1976 that are not qualified gifts for educational or medical purposes, or transfers that qualify for the annual gift tax exclusion, marital deduction, or charitable deduction.
The value of the gift is the FMV.For example, let's assume you have given taxable gifts in the amount of $3 million over your lifetime.
When you add this $3 million to your Taxable Estate, you will have Cumulative Taxable Transfers equaling $10 million ($3 million + $7 million). , At this point you can step back and determine if you need to go any further.
In 2016, the federal applicable exclusion amount is $5.45 million.
A filing is only required if your Cumulative Taxable Transfers exceeds the exclusion amount.
If it does not, you will not need to file an Estate Tax Return and you will not owe any federal estate taxes.
If it does, you will have to file an Estate Tax Return.For example, if your Cumulative Taxable Transfers equal $10 million, your estate will be taxable and you will have to file an Estate Tax Return. , Your Tentative Estate Tax equals your Tax on Cumulative Taxable Transfers minus your Tax on Adjusted Taxable Gifts.
Your Tax on Cumulative Taxable Transfers is calculated based on the Unified Tax Rate Schedule.In 2015, the top tax rate was 40%.You can subtract your Tax on Adjusted Taxable Gifts because those were taxed during your lifetime through your annual gift tax.
For example, if your Cumulative Taxable Transfers equal $10 million, with a top tax rate of 40%, your Tax on Cumulative Taxable Transfers would be $4 million.
However, you will be able to subtract your Tax on Adjusted Taxable Gifts.
Since you had Adjusted Taxable Gifts equaling $3 million, the tax you have already paid on that amount in your lifetime would be subtracted from $4 million.
Let's assume your Tax on Adjusted Taxable Gifts equals $1.2 million (this number may not be correct but you should use it for the sake of this example).
If this was the case, your Tentative Estate Tax would be $2.8 million ($4 million
- $1.2 million). , After you calculate your Tentative Estate Tax, you can begin subtracting various credits from that amount.
The biggest credit is usually the unified credit.
In 2013, the unified credit was $2,045,800.For example, you will be able to subtract the unified credit, which you will assume has stayed at $2,045,800, from your Tentative Estate Tax.
Let's assume this is the only credit you can take. , At the end of all your calculations you will be left with your final Federal Estate Tax amount.
In this example, the amount of tax owed would be $754,200 ($2.8
- $2,045,800).
As you can see, this is a massive amount of money to owe.
Because of this, it is important to understand different ways to avoid this sort of tax. -
Step 2: Identify exclusions.
-
Step 3: Calculate your gross estate.
-
Step 4: Subtract deductions.
-
Step 5: Identify taxable gifts.
-
Step 6: Determine if your estate is taxable.
-
Step 7: Identify your Tentative Estate Tax.
-
Step 8: Deduct credits.
-
Step 9: Recognize your estate tax liability.
Detailed Guide
Estate taxes and inheritance taxes are very similar and both seek to minimize the transfer of wealth after death.
If you understand how to calculate these taxes, you will also be able to understand how to avoid them.
Taxable property includes cash, securities, real estate, insurance, trusts, annuities, and business interests.A more in depth description of taxable items is included in the Internal Revenue Service's (IRS) Form 706, which is the Estate Tax Return.Look at Form 706 Instructions as well for help understanding what is considered taxable., Some items are not considered taxable for the purposes of calculating your gross estate.
Generally, you will not be taxed for items owned solely by your spouse or other individuals.
Life estates given to you in which title passed upon your death will not be included either.Also, you will not include charitable conservation easements, social security benefits, and workers' compensation death benefits., The gross estate, which will be calculated as of the date of death, includes everything you own or have certain interests in that is taxable.
Do not include any exclusionary property in this calculation.
When you calculate the value of these things, you will use the fair market value (FMV), not what you paid for it or what its' value was when you acquired it.
The FMV is the price at which something would sell between a willing buyer and willing seller if neither were under compulsion and both had a good understanding of the relevant facts.For example, let's assume that when you die you have $2 million in cash, $4 million in real estate, and $3 million in annuities.
You also had a life estate in a home that was passed to your spouse at your death as well as workers' compensation death benefits that went to your child in the amount of $750,000.
In this scenario, your gross estate would equal $9 million. , You are able to reduce your tax liability by subtracting allowable deductions from your gross estate.
When you do this, the remaining amount is considered your Taxable Estate.
In general you will be able to deduct the marital deduction, charitable deductions, mortgages and debts, administration expenses of the estate, and losses during estate administration.For example, let's assume that when you die you are able to take deductions in the amount of $2 million based on qualifying mortgages and the marital deduction.
Based on the example so far, your Taxable Estate (Gross Estate
- Deductions) equals $7 million ($9 million
- $2 million). , Under federal law, lifetime gifts are reported and any gift tax you may owe is calculated annually.
When you die, those gifts are added back into your estate for the purposes of calculating estate tax.
This results in you possibly paying taxes on the wealth that you give away, as well as the wealth you have kept and accumulated.
Taxable gifts are generally gifts made after 1976 that are not qualified gifts for educational or medical purposes, or transfers that qualify for the annual gift tax exclusion, marital deduction, or charitable deduction.
The value of the gift is the FMV.For example, let's assume you have given taxable gifts in the amount of $3 million over your lifetime.
When you add this $3 million to your Taxable Estate, you will have Cumulative Taxable Transfers equaling $10 million ($3 million + $7 million). , At this point you can step back and determine if you need to go any further.
In 2016, the federal applicable exclusion amount is $5.45 million.
A filing is only required if your Cumulative Taxable Transfers exceeds the exclusion amount.
If it does not, you will not need to file an Estate Tax Return and you will not owe any federal estate taxes.
If it does, you will have to file an Estate Tax Return.For example, if your Cumulative Taxable Transfers equal $10 million, your estate will be taxable and you will have to file an Estate Tax Return. , Your Tentative Estate Tax equals your Tax on Cumulative Taxable Transfers minus your Tax on Adjusted Taxable Gifts.
Your Tax on Cumulative Taxable Transfers is calculated based on the Unified Tax Rate Schedule.In 2015, the top tax rate was 40%.You can subtract your Tax on Adjusted Taxable Gifts because those were taxed during your lifetime through your annual gift tax.
For example, if your Cumulative Taxable Transfers equal $10 million, with a top tax rate of 40%, your Tax on Cumulative Taxable Transfers would be $4 million.
However, you will be able to subtract your Tax on Adjusted Taxable Gifts.
Since you had Adjusted Taxable Gifts equaling $3 million, the tax you have already paid on that amount in your lifetime would be subtracted from $4 million.
Let's assume your Tax on Adjusted Taxable Gifts equals $1.2 million (this number may not be correct but you should use it for the sake of this example).
If this was the case, your Tentative Estate Tax would be $2.8 million ($4 million
- $1.2 million). , After you calculate your Tentative Estate Tax, you can begin subtracting various credits from that amount.
The biggest credit is usually the unified credit.
In 2013, the unified credit was $2,045,800.For example, you will be able to subtract the unified credit, which you will assume has stayed at $2,045,800, from your Tentative Estate Tax.
Let's assume this is the only credit you can take. , At the end of all your calculations you will be left with your final Federal Estate Tax amount.
In this example, the amount of tax owed would be $754,200 ($2.8
- $2,045,800).
As you can see, this is a massive amount of money to owe.
Because of this, it is important to understand different ways to avoid this sort of tax.
About the Author
Shirley King
A passionate writer with expertise in crafts topics. Loves sharing practical knowledge.
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