Estate Taxes & Inheritance

I received the following question from the publisher of Aegist and here was my answer:

My favorite uncle from Beverly Hills passed away and left me his real estate and other assets. Are there taxes due and who pays them?

First, I am sorry to hear about your loss. From a financial standpoint, your uncle just left you a hefty inheritance and I have some good news and some bad news for you. The good news is that if Uncle Fred was worth over $12.06 million when he died in 2022, there will no estate tax or capital gains taxes on any appreciated capital assets like his Real Estate or Equities or his Business interests. The bad news is that because Uncle Fred was worth more than $12.06 million, a large percentage of the excess will need to be paid in tax under the current US Tax Code in effect at the end of 2021. This $12.06 million is called the “estate tax exemption”, which will maintain itself with small yearly increases unless Congress and the President manage to lower the limit. Although, on January 1st, 2026, the exemption gets cut by approximately ½ when the Trump tax cuts expire. Meaning you will pay tax on more of the deceased’s assets.

Now, let’s go over what happens when Uncle Fred passes away and leaves his estate to you. Let’s also suppose his wife, your very wealthy Aunt had already passed away years 10 years earlier and therefore you are next in line as his favorite heir Thus, Uncle Fred’s whole estate was left to you and along with it, the administration and tax responsibilities related to the passing of his estate.

What are your choices at this point? You could opt for an estate waiver or “disclaimer”, which is a legal document that declines the rights to the inheritance. This could be an option in case you don’t want to assume the responsibilities of maintaining the real estate or businesses left behind or if your uncle had large creditor issues, or even if you would rather pass the inheritance to your children because your estate was already large enough. However, let’s say that you wanted the entire estate.

As you already know, an estate is only subject to estate taxes if the amount of the estate exceeds $12.06 million (for 2022). Their estate surpassed this amount, but with careful planning, they were able to mitigate some of the estate taxes. The estate tax % has changed many times throughout its 106-year history, with the highest rate being in 1941-1976 with an estate tax of 77%. The exemption amount was only $600,000 for much of that time. Today’s rate is one of the lowest in history at 40%. Any amounts over $12.06M left in the estate at death would be subject to that 40% tax due within 9 months of Uncle Fred’s death. The executor or successor trustee would be responsible for paying those taxes before distributing the assets to you, his only heir. If you were the executor, then you would have to make sure the estate tax return gets filed and estate taxes get paid before distributing the excess to yourself.

In addition to Federal Estate Taxes, four states (Kentucky, Nebraska, New Jersey, and Pennsylvania also have a separate inheritance tax, although Uncle Fred lived in California. The state inheritance tax is levied upon the person inheriting property while the Estate Tax is levied on the entire estate. There are also another 11 states with their own estate tax in case you escaped the Federal Estate Tax and one state that has both Estate and Inheritance tax – Maryland. Surprisingly enough, California, already the highest tax state, does not currently have a separate Death Tax, although there is a proposed bill in CA to take 40% of all assets over 3.5M up to the current Federal exemption amount.

As mentioned earlier, your Aunt and Uncle knew they would not live forever and wanted you, his favorite niece or nephew to inherit as much of their hard-earned wealth as possible.

The 1st thing Fred did was determine is the fair market value (FMV) of all of the assets in his estate, which were not the same as what he originally purchased them for. Luckily, you would not have to pay capital gains taxes on all the gains in his estate, but you also do not receive any tax advantages for losses, although there may be some new depreciation benefits. Once Fred had a general idea of the value of his estate, it was time to evaluate some strategies on how to pass on this estate.

The first strategy he used was gifting away small chunks of his estate every year. Gifting is also subject to tax and rates can vary between 18% and 40%. However, if the annual gift is under $16,000 for individuals and/or $32,000 for married couples there isn’t a need to file a federal gift tax return or pay any taxes. This gift exemption just increased in 2022 from $15,000 where it was for a number of years. Your Aunt and Uncle had started planning years before they passed away and that’s what has paid for your college and your kids’ private education. They were able to transfer a hefty amount tax-free to you and your children because they started so early. As you know, you and your wife and son and daughter each received $16,000 on January 1st, 2022 from Uncle Fred. This was a tax-free gift to help lower Uncle Fred’s estate.

This gifting strategy is often accompanied by Crummey trust which basically allows Uncle Fred to gift the same amount but to a trust where the money can be placed and invested into various ways to multiply his estate to you and your children, tax-free.

Uncle Fred and his wife also utilized another strategy called the unlimited marital deduction. You can leave any amount you want to your spouse without any estate taxes upon your death. Your Aunt left most of her large estate to Uncle Fred upon her death and no taxes were due at that time. As a matter of fact, all capital assets in her name and their joint name received a step-up upon her death. That means that upon the later sale of one of those assets, Uncle Fred would have used her date of death value to figure out if there was a capital gain tax due or a capital loss.

Another strategy Fred used was a Bypass trust. This trust allowed your Aunt to place $5.12M (the exemption amount in 2012) of her assets into the Bypass trust upon her death and freeze that part of her estate. This trust allows the assets to continue to be available to Fred for certain circumstances. And even though these assets have grown considerably, and you just inherited them outright with no estate tax, you would have to pay capital gains taxes on any asset that you sell in the future, based on her date of death asset valuation from 2012.

One of the most effective estate planning strategies available is utilizing an Irrevocable Life Insurance Trust (ILIT). This type of trust is composed of specific provisions that allow it to own one or more life insurance policies. If this trust is constructed and administrated properly the death benefit received by the policy will not be subject to estate tax or income tax. The fact is that many wealthy families utilize this type of trust to allow insurance companies to pay their family’s entire estate taxes for pennies on the dollar. Imagine if you’re worth $112,060,000 (for easy math) and you know that upon your death, 40% of the remaining 100M = $40,000,000 will be due to the IRS within 9 months of your death. You don’t want to have your heirs sell your business or the real estate that you worked so hard for your entire life. So you planned ahead and secured income tax-free and estate tax-free life insurance to pay those pesky estate taxes and your heirs kept the entire 112K estate in one piece.

There are many ways our clients strategize using Irrevocable Life Insurance Trusts, such as utilizing private loans or public loans in addition to or instead of making gifts to the trust. There are also various charitable strategies our clients use to lower their estate taxes. And there are also various trusts that Estate Planning attorneys utilize to help reduce one’s estate while they are still alive. One is the Intentionally Defective Grantor Trust (IDGT). This trust allows the assets to continue generating income to you while you are alive. And although this income is still subject to income tax, the assets in the trust are not counted into your estate. This and all trusts are subject to many conditions and limitations, so make sure to thoroughly review this option with your attorney before committing to it. Keep in mind, that many of these “trust” planning techniques were almost lost with the Build Back Better legislation that failed to pass the Senate at the end of 2021, which could be revived soon.

In the final analysis, I am sure you are morning the great loss but also grateful to Uncle Fred for the large inheritance you received and the fact that he and his wife did some excellent planning. After all, they left you many extra $ millions by lowering the amount owed to your other uncle – Uncle Sam, upon their deaths. Now it’s up to you to act and plan now. The Federal Debt just passed $30 Trillion for the 1st time in history. Taxes will go up, and the estate tax which affects a small % of Americans is easy to pick for a tax hike. The historically low estate tax combined with the extra-large exemption will be a thing of the past in just 4 short years and predictably sooner if the current administration can get it done. Right now, you have the ability to freeze about $24 Million of your and your spouse’s estate and shield these assets from future estate taxes.

If you would like to learn more about how we at Gurman Wealth Management, Inc. help our clients lower their taxes and protect their hard-earned assets, we can be reached at 310-417-9040.

If you would like to read the article in Ageist, here\’s the link:

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