Estate planning is that unique time when death and taxes come together. The game plan for many people is to give more of their money to their heirs when they pass and less of it to the government. Here’s a simple overview so you can be in the know. General Estate Planning Tax Issues
The federal government assesses a tax on the assets or things you own that are transferred to others. If the transfer occurs while you’re alive, any tax applicable is called a gift tax. If it happens after your death, it’s called an estate tax, which is where the term death tax comes from. Many states also assess tax on estates as well. Both federal and state estate taxes are in a state of flux. The new federal changes for 2011 and 2012 are temporary, meaning that unless further federal action is taken, the federal tax system in 2013 may look very different. General Estate Planning Tax Issues
Presuming that you don’t have your passing dialed in by calendar date, it behooves you to know the game. If you have more money than what current exemptions allow for, you have tax issues. General Estate Planning Tax Issues
What’s in Your Estate and What’s Not
What does the IRS define as your estate? It’s all your assets, and by that we mean everything (including some things you’ve “given away” during your life), which is your “gross” estate. To find out your net or taxable estate, you subtract debt, expenses and losses. The “taxable” estate further subtracts out your charitable donations and gifts to your spouse.
Many individuals leave all of their estate to their spouse or a charity. If this is the case, nothing is taxed, but your executor will still need to complete and file the required forms if your gross estate is over the exclusion amount. And the tax man must be faced when the surviving spouse dies.
So now that you know what an estate is, what’s taxed and what’s not, what else should you look for?
“The thing I find people are most unprepared for is the fact that they could have both income tax and estate taxes to deal with. The income tax piece is something you can plan for, whereas the estate is a changing picture,” says Patricia Kummer, president of Kummer Financial Services in Highlands Ranch, Colo.
Many executors and heirs believe they only have to worry about the estate, or inheritance tax. But Kummer advocates being prepared for income tax as well.
“We don’t run into a lot of taxable estates, but the income taxes can be a real killer. People have the attitude that they are not going to have a taxable estate because they don’t consider themselves wealthy. There’s going to be income tax due depending on where the money comes from, selling a house at a gain, inheriting an IRA,” she says. If there’s no remaining spouse, the IRA needs to have a secondary beneficiary named. If not, the money may be subject to income tax sooner.
There are more IRA wrinkles, Kummer added. 401(k) plans should be converted to IRAs since they currently offer more tax protection. General Estate Planning Tax Issues
Valuing businesses and homes can be a big deal for the middle class, Kummer says. For example, a business owner who started his firm from scratch may not consider it worth much, but the IRS will mostly certainly have a different opinion. They will value it much higher and force the valuation into the estate tax calculation.
There needs to be a “business continuity plan,” that deals with taxation. Should the business be sold? To whom? Employees? An outsider? Analyze whether it is prudent to buy a “second-to-die” life insurance policy on the surviving spouse that will cover taxes in the event of a high IRS business valuation.
As an estate owner, you should check to see if your house is valued on a “stepped-up” basis, meaning that the period for calculating the appreciation of your home starts at the time of death, not when the deceased bought it. There’s a huge difference in the tax calculation. Presently, stepped-up basis calculations are kinder to estates.
Tax-minimizing trusts are another way to deal with estate taxes. They are usually prepared by an estate attorney and have their own set of issues and rules.
A good first step in understanding how the estate tax framework will apply to your personal situation is to take an inventory of your assets. What do you own, and what’s the total? Is it equal to or below the current estate tax exclusion amount? Regardless of whether it is or isn’t, now may be the right time for you to discuss the situation with a trusted advisor who can help you meet your goals.
