Estate taxes are levied against an individual’s estate at death. The part of the estate that gets taxed is the part exceeding a specific exempt amount ($5.34 million in 2014). Also excluded from federal estate taxation are the amounts left to a surviving spouse that qualify for the marital deduction.
The impact of these high tax rates can be staggering. In larger estates, they can result in millions of dollars going to the IRS instead of to an estate owner’s heirs. Fortunately, methods are available to help taxpayers minimize transfer taxes due at death.
One method involves a program of making nontaxable gifts to others during the taxpayer’s lifetime. This helps to shrink the size of the estate remaining when the gift-giver dies. The maximum amount that can be given gift tax-free each year to any one person is $14,000 in 2014. Up to this amount may be given to as many people as the taxpayer chooses. Plus, a married person’s spouse may also give up to the same limit to any number of people, thus doubling the tax-free gift. This reduces the couple’s estate and lets their heirs enjoy their inheritance sooner.
Each taxpayer also has a lifetime gift tax applicable exclusion of $5.34 million (the unified credit for gift and estate taxes).
Another technique for reducing transfer taxes is an irrevocable life insurance trust. With this method, the estate owner makes gifts of cash to the trust which pays premiums for a policy owned by the trust. The annual premium may be any amount up to the gift tax-free maximum, $14,000 in 2014, per trust beneficiary with a present interest. And, just as with any lifetime gifts, the estate is reduced significantly. The taxpayer’s heirs are beneficiaries of the trust. When the taxpayer dies, policy proceeds are paid to the trust, free of both federal income and estate taxation. This money is then held or distributed by the trust under the terms of the trust instrument. Married couples get special breaks. The marital deduction permits the exchange of unlimited assets between spouses without incurring federal gift or estate tax. Taxes are due only when the second spouse dies. Also, spouses can elect to split gifts actually made by one of them, thereby doubling the gift tax annual exclusion (i.e., $28,000 in 2014).
Charitable gifts, private annuities and installment sales are among other strategies that can be used effectively to transfer assets out of an estate during a taxpayer’s lifetime, reducing the size of the estate that will be subject to transfer taxes at death.
When looking at ways to minimize transfer taxes, individuals and couples must carefully analyze their personal situations and understand all available options. The best methods, using the assistance of professional advisors, can only be determined by a careful analysis of what they want from their assets now, during their lifetimes, and at their deaths.