How to Minimize Taxes While Transferring Wealth
James Zahansky, AWMA®
Principal/Managing Partner, Investment Advisor & Chief Goals Strategist
Whether you’re planning how to pass down your estate to loved ones or you’ve just inherited part or all of an estate yourself, the process can feel overwhelming, and a wide range of emotions are often involved. Typically, thinking about taxes is the last thing you want to do. But failing to do so can result in the needless loss of a sizeable chunk of the wealth that you or your loved one worked so hard to earn and preserve.
Creating a tax-efficient strategy for the transfer of wealth is a complicated process. The right tactics will be a bit different for each individual and family and it’s strongly encouraged that those decisions be made with the guidance of professionals (more on that later). But at a high level, here are six important steps to consider.
First, Understand The Tax Obligations
There are two types of tax to be aware of: estate tax and inheritance tax. Estate tax is applied to the estate’s assets before the assets are allowed to pass on to beneficiaries. Inheritance tax is applied after the assets have been inherited and are paid by the inheritor.
According to the IRS, individuals can leave up to $12.92 million to their heirs without paying any federal estate tax, as of 2023. But if you’re leaving more than that (or you’ve inherited more), the estate could be hit with a 40% federal tax bill. In addition, there are 13 states that levy state estate taxes as well, including Connecticut, and their thresholds are lower. The good news is, there is no inheritance tax at the federal level. However, there are six states that currently employ a state inheritance tax: Nebraska, Iowa, Kentucky, Pennsylvania, New Jersey and Maryland. If you’ve recently received an inheritance, it’s a good idea to discuss all of the tax implications the inheritance could have in the upcoming tax year and later down the road with your financial planner or CPA as soon as possible.
Establish a Trust
Trusts are legal documents you set in place to protect and control your assets after death or in the event of incapacitation. There are four main types of trusts: revocable trusts, irrevocable trusts, living trusts and will trusts.
For some couples, establishing a revocable trust may help in minimizing estate tax burdens. Couples with a high accumulation of wealth and assets may want to work with their legal and financial professionals to create trusts that help shelter the remaining spouse from estate tax burdens after the passing of their loved one.
Certain types of trusts may also help to relieve the tax burden on the beneficiary of an IRA account. Because most beneficiaries must take the full value of the account through distributions made over no more than a 10-year span, this can result in a large tax burden to the beneficiary if it substantially increases his or her income during those 10 years. But certain types of trusts could potentially help non-spousal beneficiaries (such as children or grandchildren) bypass the 10-year rule, thus creating more tax-beneficial distributions for them.
Married Couples May Want to Set Up an Exemption Transfer
If you are receiving an inheritance from your spouse, you could also receive any unused tax exemptions. Your spouse may elect to pass their exemptions to you on a filed estate tax return, which you both can prepare in advance as a way to avoid further tax implications.
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Don’t Forget About Deductibles
If you are the one inheriting wealth, there are deductions you can take with respect to the amount of taxes on the assets. There are areas in Form 706 from the IRS that allow for deductions including funeral expenses, debts from the decedent, mortgages and liens, charitable gifts made during your lifetime, and bequests to your surviving spouse. As you make end-of-life preparations for your loved one from whom you will inherit, and as you manage the estate after their passing, keep in mind the various expenses that may arise that can be put towards deductions. Tracking your expenses during this time can allow for fewer taxes being made on the inherited property.
Prepare for Capital Gains Taxes
The tax you pay on the property and money you’ve inherited could increase even after you’ve paid inheritance tax. Gifts from an estate such as a stock portfolio, vacation properties, family homes, cars, antiques, jewelry, art, and other such items are also subject to capital gains tax if the inheritor sells them down the road. This tax is levied on the amount that the item has appreciated since it was inherited. For example, if you received a vacation property that was valued at $500,000 and sold it three years later for $750,000, you would be taxed on the long-term capital gains of $250,000.
However, you could owe less in inheritance tax than you think depending on your relationship to the giver as well as the overall value and location of the property. Exploring the latest inheritance tax laws can help you avoid certain tax implications that could cause you to owe more than you should.
Assemble a Team of Trustworthy Professionals
The steps outlined above are only effective if they’re done correctly and strategically, and it’s very often a complicated process. Because of this, it is highly recommended that you assemble a team of financial professionals you can trust to have your best interest at heart. This team should include a fiduciary financial advisor, a CPA, an attorney and an insurance agent. Together, they can help you understand, plan for and manage the implications of a transfer of wealth.
We pride ourselves on providing fiduciary financial planning and wealth management services to generations of clients at Weiss, Hale & Zahansy Strategic Wealth Advisors. We take a long-term, comprehensive, and tailored approach built on our Plan Well. Invest Well. Live Well.™ strategic process, and we make it our mission to provide an exceptional wealth management experience for every client, at every touchpoint.
If you’d like to learn more about how we can help you to create a strategic financial plan for you and your family, contact us at (860) 928-2341 or info@whzwealth.com.
Principal/Managing Partner James Zahansky, AWMA®. Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Weiss, Hale & Zahansky Strategic Wealth Advisors does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. 697 Pomfret Street, Pomfret Center, CT 06259, 860-928-2341. www.whzwealth.com
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