What Is Estate Tax and How Can I Manage It?

Almost all U.S. workers must contribute a portion of their paychecks to Social Security. If you have many valuable assets you want to pass on to your family after your death but don’t practice solid tax planning habits, estate and inheritance taxes could reduce your estate and disrupt your strategy. Understanding estate planning and gathering the right resources can help you reduce your tax liability and help you keep your assets intact.

What Is the “Death Tax”?

The federal estate tax, also known as the “death tax,” is a number of assets owed upon your death. The federal government and some states impose an estate tax. Following an assessment of the total value of your estate, which consists of stocks, bonds, life insurance, and cash, you may owe a portion of your taxable estate.

Estate taxes can negatively impact your financial plan by significantly reducing the assets you can legally transfer to your surviving spouse or children. The federal estate tax rate alone can reach 40%. If you had $1 million worth of assets over the federal estate tax exemption limit, you would owe the government $400,000, leaving you with $600,000 to transfer to your loved ones. With a state estate tax rate, that amount is even less.

Who Pays Estate Taxes?

As of 2022, the federal estate tax applies to $12.06 million per person. While many estates are too small to incur an estate tax, those affected may find it challenging to navigate without a proper estate tax planning strategy. Building a comprehensive system and saving with state and federal estate tax exemption limits in mind ensures there are no surprises when it’s time to distribute your assets.

Are Inheritance Taxes and Estate Taxes Connected?

Estate and inheritance taxes are not the same. An inheritance tax is a state tax that impacts assets inherited from someone after their death. The person who inherits the assets pays the tax amount, which depends on three factors:

The amount inherited
The inheritor’s relationship with the deceased
The inheritor’s tax situation

Inheritances are often taxable only when the inheritor isn’t related to the deceased. Surviving spouses are exempt from inheritance tax, and in some cases, so are children. The primary difference between inheritance tax and estate tax is that with the former, the inheritor is responsible for the tax amount, while the latter is taken out before the assets are given away.

Which States Have an Inheritance Tax?

Six states enforce an inheritance tax:

  • Kentucky
  • Iowa
  • Maryland
  • New Jersey
  • Nebraska
  • Pennsylvania

It’s possible to have to deal with an estate tax and an inheritance tax simultaneously. Taxable estates in Maryland have to pay the state and IRS before the inheritors pay yet another amount to the state.

How Can I Use Estate Tax Planning To Reduce My Liability?

If you have a large estate, there are ways to manage your tax burden. Protecting your assets requires research, careful planning, and proactive measures. The federal estate tax exemption limit is set to return to $5 million in 2026 with the sunsetting of the Tax Cuts and Jobs Act. It’s vital to shelter your assets before the new limit damages your financial goals.

Here are a few tips to strengthen your tax planning and reduce your tax liability:

Reduce Your Taxable Estate With Gifts

As of 2022, individuals can give away $16,000 per person, per year before triggering a gift tax. A married couple can give away $32,000 to one person, with no limit to the number of recipients. You can reduce your estate tax burden by gifting assets from your taxable estate to your heirs every year. Paying for medical bills and tuition and offering the occasional gift is an excellent way to shrink your estate without worrying about tax consequences.

Purchase a Life Insurance Policy

Investing in an irrevocable trust is an effective way to minimize your tax burden. Irrevocable trusts are agreements that can’t be changed once created. Once the grantor moves assets into the trust, they have no ownership over the account. There are many trusts to choose from, and discovering which one fits your situation takes time and patience. From dynasty trusts to spendthrift trusts, there are many ways to build a trust that accounts for your and your family’s personal and financial needs.

Plan Your Estate Tax Strategy With Summit Wealth Partners

Keeping up with all the laws and regulations that impact your estate is exhausting. You don’t need to tackle estate tax planning alone. Summit Wealth Partners believes you deserve a well-constructed, rock-solid financial plan that suits your unique long- and short-term goals. We help you build a strategy with clearly-defined steps, and if your situation ever changes, we adjust our approach and make recommendations that best align with your requirements.

Our financial plans evolve with you. Are you ready to shelter your assets? Reach out to our team today.

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