ESTATE Tax Planning
Who pays the Estate Tax?
Estate tax, sometimes referred to as the “Death Tax”, is an important element of estate planning. If the total amount of net assets that you leave for your heirs exceeds a certain threshold amount (“Applicable Exclusions Amount”), the Federal government will levy and collect the estate tax from your estate. In other words, your heirs will receive your assets less the tax to the government.
What are the transfer tax exemptions?
The following chart shows the current transfer tax exemptions in comparison to last year:
|Estate Tax Exemption
|Lifetime Gift Tax Exemption
|Annual Gift Tax Exclusion
How much assets do I need to have before I worry about the Estate Tax?
For individuals, if your estate’s value is under the Applicable Exclusion Amount, you do not worry about estate tax liability (that is if you were to die in that particular year). In 2022, the exclusion amount is $12,060,000 (increased with inflation from $11,700,000 in 2021). A husband and wife can enjoy a total of $24,120,000 estate tax exclusion in 2022.
California does not have a state estate tax regime. However, if you live in other states, your estate may have to pay both Federal Estate Tax and State Estate Tax.
Exactly which of my assets will be included in my estate for “estate tax calculation” purposes?
Everything you own will be included and counted to determine whether or not your estate will have to pay the government a hefty estate tax.
You might be surprised to learn that all life insurance policies that you own will be included in your estate, when calculating your total assets for estate tax purposes. So the life insurance policy that you purchased for protection of your loved ones, may actually cost your estate an expensive tax if you don’t use a special planning technique!
Do I pay taxes on life insurance?
The answer may be YES as to the Estate Tax, depending on total amount of your assets. Life insurance proceeds will be added to your other assets to determine whether or not your total estate is under or over the exemption amount. For example, let’s assume you own a life insurance policy in the amount of $7,000,000 and you also own other assets worth $8,000,000. If death occurs in 2022, the IRS will treat your estate as owning $15,000,000. If you are unmarried, the first $12,060,000 is exempt from tax, but the balance ($15,000,000-$12,060,000= $2,940,000) will be subject to the top marginal rate of 40% or $1,176,000 estate tax liability.
Also, all of your retirement plans and any property that you may have inherited from anyone, will also be included in your estate and will be counted for estate tax liability purposes.
Can I make the life insurance proceeds Death Tax free for my family?
Absolutely. However, there is a specific planning technique to accomplish tax savings on life insurance.
So life insurance adds to the value of my estate, thus possibly creating a tax liability. Is there any way to make my life insurance tax-free?
Remember we are not talking about “income tax”, since most life insurance proceeds are income tax free. We are talking about the largest tax ever that most taxpayers are not aware of and are not accustomed to paying. We are talking about “estate taxes” or “death tax” that will only come into play when we have died and our heirs will have to deal with it. So the question is, can we make our life insurance “estate tax free” for our heirs, and the answer is YES, absolutely we can. There are advanced strategies and vehicles such as Irrevocable Trusts by which you can enjoy all the benefits of your life insurance policies and at the same time, make the death benefits Estate Tax free for your beneficiaries upon your death. Otherwise, if you do not create these special trusts and simply purchase a life insurance policy (with you as the owner of the policy), your beneficiaries (heirs) may end up paying 40% estate taxes on the amount of your life insurance policies, depending on total value of your estate at the time of death.
How about giving away my assets during my life?
You may “give away” (gift) your assets in two ways:
In 2022: you may give away $16,000 per person to as many individuals as you like without incurring gift tax liability. By doing so, you can trim your estate somewhat. Or you may use your lifetime exemption up to $12,060,000 and “gift”/give away your assets to anyone you wish.
Can I give away more than $16,000 to an individual in 2022?
You may give away as much as you like. You may give away a total of $12,060,000 in 2022 without tax liability and use up to 100% of your Estate Tax Exclusion Amount if you wish (provided you have not given away or gifted any of your assets before). For married couples, this means that they can give $32,000 per year per recipient beginning in 2022. As an example, if a married couple has 3 children and 5 grandchildren, they may transfer a total of $256,000 in 2022 to their descendants (children & grandchildren) without touching their combined $24,120,000 gift tax exemption, thus allowing them to transfer further substantial assets gift-tax free at a later time. Not only are the assets removed from the taxpayer’s taxable estates, the assets’ future appreciation also avoids gift & estate taxes.
However, this example is not designed to encourage anyone to give away substantial assets for various tax and non-tax reasons. This example is for illustration purposes only. Just remember, we only have one (1) exemption, not two exemptions. Lifetime Gift Tax exemption is the same as Estate Tax Exemption. Therefore, you can either use your exemption during your lifetime by gifting away your assets to your loved ones or you may keep all of your assets and transfer them to your heirs after your death. Either way, the total exemption is the same. There are substantial advantages and disadvantages of gifting your assets during your lifetime (which should be your major discussion with your estate planning attorney). Also, there are strategies by which “gifts” to your children or other beneficiaries can be “leveraged”, i.e., maximized.
Does the annual allowance of $16,000 use up my $12,060,000 exclusion?
No. The annual gift tax exemption amount of $16,000 per person (per donee) is in addition to your lifetime gift/estate tax exclusion amount of $12,060,000 in 2022. In other words, even if you give away (gift) $16,000 to 10 individuals (totaling $160,000), you still have $12,060,000 lifetime gift/estate tax exemption to utilize during your lifetime.
So is gifting of all types of assets appropriate?
It may or may not be beneficial for you and your loved ones to engage in lifetime gifting. For instance, if you are planning to give away (gift) real estate to your family members, it would be to your best interest to seek professional advice, because by doing so, you may be creating or enlarging other tax liabilities for your loved ones (especially if the real estate appreciates in value after the gifting).
How much can I gift to my Non-U.S. Citizen Spouse?
U.S. Citizen Spouses may transfer unlimited amounts to each other without incurring any gift tax. However, any assets that exceeds the couple’s combined Estate Tax (Death Tax) Exemption ($24,120,000 in 2022) will be taxed at the death of the second spouse’s death (surviving spouse). Therefore, transferring assets from one spouse to the other spouse only postpones the Death Tax that the IRS will eventually collect.
Gifts to a Non-U.S. Citizen Spouse, however, are limited. Since a Non-U.S. Citizen Spouse may not be subject to U.S. Estate Tax (Death Tax), one cannot transfer unlimited assets to a Non-U.S. Citizen Spouse and avoid U.S. estate taxation at the death of the Non-U.S. Citizen Spouse. Thus, when the recipient spouse is not a U.S. Citizen, and regardless of whether the Non-U.S. Citizen spouse is a U.S. resident or U.S. nonresident, the amount of tax-free gift is limited to an annual exclusion amount.
For calendar year 2022, the first $164,000 of gifts to a spouse who is a non-U.S. Citizen, are not included in the total amount of taxable gifts.
Will the current high exemption of $12,060,000 be there forever?
No, the current 2022 exemption of $12,060,000 is scheduled to be cut in half on January 1, 2026. So if you have substantial assets that appreciate as time goes by, it is in your best interest and your loved ones’ best interest to consult with an experienced estate planning attorney