Let’s begin with a look at the numbers. The current federal estate tax exemption is $11.7 million for individuals and $23.4 for couples filing jointly. Assets in excess of these amounts will be taxed at a graduated rate between 18 and 40 percent depending on the size of the estate. In Maryland, the 2021 exemption is $5 million and the graduated rate for estates above that amount is 8 to 16 percent.
The good news, if anything about paying taxes can be considered “good,” is that with proper planning you can minimize or even eliminate your estate being subject to estate tax. Here are six ways to do so.
Make Gifts to Family.
Perhaps the simplest way to avoid estate taxes is to give assets to loved ones while you are alive so that your estate will be under the threshold when you pass away. The gift tax exclusion for 2021 (for federal tax purposes) allows you to give any individual up $15,000 per year completely tax free ($30,000 if you are married and filing jointly) and there’s no limit to the number of people you can benefit. You may also give away up to 11.7 million during your lifetime in excess of the exclusion amount without paying any gift tax. However you will need to file a gift tax return, which enables the IRS to track the total of your lifetime gifts in excess of the exclusion amount. At death, your exemption from estate taxes will be reduced by the amount of these excess gifts.
Maryland has no gift tax. Accordingly, you can make gifts, in any amount, at any time (even on your deathbed) and reduce the size of your Maryland Estate. This can be an extremely valuable tool.
Create an Irrevocable Life Insurance Trust.
While life insurance proceeds are typically income tax free, if they are part of your estate after you pass away, they could become subject to estate tax. By transferring life insurance into an irrevocable life insurance trust, your death benefits would not be considered part of your estate. It is important to note that if you die within three years of making the transfer, your death benefits would still be considered part of your estate and, therefore, taxable.
Give to Charity Through Trusts.
Transfers to a charitable lead trust (CLT) or a charitable remainder trust (CRT) can also be an effective tax mitigation strategy for those with a charitable purpose. With a CLT, you can provide an income stream to the charity, reduce the value of your estate, and receive a tax break. After you pass away (or following a pre-determined amount of time), the assets left in the trust will go to your beneficiaries. If you have rapidly appreciating assets, a CRT may be a good option. While you’re alive, it lets you earn income from the assets you have transferred to the trust, avoid capital gains taxes on those assets, receive a tax deduction, and reduce your taxable estate. When you pass away, or after a specified period of time, remaining assets will go to the charity named in the trust.
Set Up a Family Limited Partnership.
If you have a family business and/or assets such as real estate that you would like your children to own upon your passing, you may want to consider a family limited partnership (FLP). This usually involves making yourself the general partner of the business (or other assets) and your loved ones the limited partners. You will retain control of the business and assets while you’re alive, and your loved ones will have a stake in them. When you pass away, your taxable estate will be smaller and your limited partners—your loved ones—will own the business and assets. Your loved ones may also benefit from breaks on income, estate, and gift taxes.
Create a Qualified Personal Residence Trust.
A qualified personal residence trust (QPRT) allows you to transfer the ownership of your home to a trust. You can continue to reside in the home without paying rent and when the trust’s term ends your family can take over the property. This strategy allows you to freeze your home’s market value, avoid paying gift taxes, and shrink the size of your estate. However, if you pass away before the end of the term of the trust, the property will continue to be part of your estate.
Take Advantage of Portability in Maryland.
“Portability” enables a surviving spouse to claim the deceased spouse’s “unused” exemption. We have mentioned that Maryland’s estate tax exemption is currently $5 million. By taking advantage of portability, the surviving spouse can protect up to $10 million in assets from Maryland estate taxes. It is worth noting that the federal exemption is also portable, but not all local jurisdictions (Washington, D.C., for example) are portable.
With proper planning, it is possible to structure your assets in such a way that estate taxes can be minimized or eliminated entirely. We invite you to call the Law Offices of Clifford M. Cohen at (202) 895-2799 to schedule a meeting and discuss your options. We can meet in-person at our office or virtually via Zoom and other platforms.