End-of-life planning is a complicated process in and of itself that is often only made more stressful when having to consider estate planning in a way that avoids (or at least minimizes) the financial impact of death taxes. Navigating through the technical jargon is difficult enough, and being under pressure to make quick decisions certainly doesn’t ease the burden of making these difficult financial choices. To add to the stress, the recent Tax Cuts and Jobs Act of December 2017 changed many aspects of estate taxes. However, understanding the basics of the new tax legislation in regards to death taxes can help ease much of the burden when formulating end-of-life plans.
There are a few basics to the new estate tax that can save most citizens money, but first it must be understood that in the United States, estate tax and inheritance tax are not the same tax. While this can be confusing because the terms are interchangeably used in most countries, in the United States, estate taxes are levied on representatives of the deceased person, while inheritance taxes are levied on the beneficiaries of the estate. References to changes in the estate tax primarily include changes to the transfer taxes, or the federal gift tax, exchange tax, and generation-skipping transfer (GST) tax. The three taxes will be discussed in more detail, meanwhile, it is important to remember that state and local taxes vary and can ultimately impact the function of the estate taxes. To see a comprehensive state tax chart, see the link. However, the most important thing to remember is that because of the new tax act, estate taxes mainly affect only the wealthiest citizens. The raised exemptions enable the majority of citizens to be exempt from heavy taxes.
Transfer Tax Exemptions
With regards to the transfer tax exemptions, the most prominent change was that the lifetime exemption bar was raised from $5 million to $10 million, with the adjustment for inflation. This raise expires after the year 2025. However, specific changes have been underway regarding the new estate and GST tax exemptions.
Estate and GST Tax
The largest effect the new act had on estate and GST taxes was that the exemption bar was raised from $11.18 million to $11.4 million. Those estates with assets above $11.4 million have to pay tax rates of 40%, but there are ways to deduct those rates that will be discussed later. Furthermore, because of portability rules, a living spouse can transfer a deceased spouse’s unused tax exemption up to $11.4 million, equaling a total of $22.8 million in transferrable assets. The caveat to all transfer taxes is that the act expires in 2025 and all tax exemptions revert back to the 2017 tax rules. These same rules and exemptions apply to GST taxes.
Gift Tax
The annual exclusion amount in regards to gift taxes was also increased and now equals $15,000 in annual gifts. This was raised from the previous amount of $10,000. These gifts are unlimited in number, but can only be given to the same recipient once per year. Furthermore, portability rules are also applicable to annual gift exclusions, meaning that a couple can transfer up to $30,000 to an individual, tax free. With gifts, it is important to remember that gifts to U.S. spouses are never taxed, regardless of the amount. However, gifts to non-U.S. spouses are taxed at 40% after the exemption bar of $155,000. This amount has also been increased from the previous bar of $152,000.
Minimizing Taxes
The most important factor to keep in mind when trying to minimize taxes is the importance of planning ahead and understanding changes. As tax laws are constantly changing, and the changes in the new act are set to end in 2025, it is important to frequently check tax laws and policies in order to stay informed and prepared. This includes checking state and local taxes as they may vary from federal taxes. One excellent method to minimize tax costs on estates is through frequent gifting. Charitable cash gifts are tax deductible up to 60%, a change from the previous 50%. Furthermore, charitable gifts towards tuition costs and medical bills are completely tax free, as long as they are paid directly to the school or medical institution. These gifts are unlimited, making them a great way to minimize taxes and stay under the tax exemption bar.
However, one of the best things an individual can do when navigating death taxes is to use the assistance and professional knowledge of a financial advisor. Mistakes in estate planning can have dire effects on beneficiaries and loved ones, and the best way to avoid these mistakes is through the assistance and watchful care of a financial advisor. Financial advisors understand tax laws and exemptions, are more aware of changes to policies, and can better predict the ways to positively minimize taxes. With this in mind, it is still important for an individual or family to understand at least the very basics of estate taxes in order to protect their assets, finances, and future for themselves and loved ones. Through this understanding and preparation, an individual or family can receive the most benefits from the new tax legislation.