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Estate Planning

Estate PlanningWhat is ‘Estate Planning’?

Estate planning is the collection of preparation tasks that serve to manage an individual’s asset base in the event of their incapacitation or death, including the bequest of assets to heirs and the settlement of estate taxes. Most estate plans are set up with the help of an attorney experienced in estate law.
Some of the major estate planning tasks include:
  • Creating a will
  • Limiting estate taxes by setting up trust accounts in the name of beneficiaries
  • Establishing a guardian for living dependents
  • Naming an executor of the estate to oversee the terms of the will
  • Creating/updating beneficiaries on plans such as life insurance, IRAs and 401(k)s
  • Setting up funeral arrangements
  • Establishing annual gifting to reduce the taxable estate
  • Setting up durable power of attorney (POA) to direct other assets and investments
Estate planning is an ongoing process and should be started as soon as one has any measurable asset base. As life progresses and goals shift, the estate plan should move to be in line with new goals. Lack of adequate estate planning can cause undue financial burdens to loved ones (estate taxes can run higher than 40%), so at the very least a will should be set up even if the taxable estate is not large.

Estate Taxes

Estate taxes are levied on an heir’s inherited portion of an estate if the value of the estate exceeds an exclusion limit set by law. The estate tax is mostly imposed on assets left to heirs, but it does not apply to the transfer of assets to a surviving spouse. The right of spouses to leave any amount to one another is known as the unlimited marital deduction, but when the surviving spouse who inherited an estate dies, the beneficiaries may then owe estate taxes if the estate exceeds the exclusion limit.
Because the estate tax can be quite high, careful estate planning is advisable for individuals who want to leave significant assets to their beneficiaries or heirs without facing a lot of sales tax. As of 2016, the Internal Revenue Service (IRS) only requires estates with combined gross assets and prior taxable gifts exceeding $5.45 million to file a federal estate tax return and pay estate taxes. As a result, if someone has a $5 million estate, there are no estate taxes levied upon it at his death.

Relationship Between Estate Tax and Gift Tax

While an estate tax is levied on an individual’s assets and estate after death, gift taxes apply to funds given away while the taxpayer is living. Gift taxes prevent individuals with large estates from giving away all of their assets to their heirs during their lifetimes to avoid estate taxes.
However, the IRS offers generous gift exclusions. As of 2016, the annual exclusion is $14,000, meaning tax filers can give away $14,000 to each and every person they select. If a tax filer wants to give the maximum gift to 10 people, for example, he can give away $140,000 without facing any tax penalties. in contrast, if he gives $20,000 to a single person, he has exceeded the exclusion by $6,000. When he dies, this sum is added to his estate when calculating his estate tax.

Difference Between Estate Tax and Inheritance Tax

An estate tax is applied to an estate before the assets are given to the beneficiaries. In contrast, an inheritance tax applies to assets after they have been inherited by someone. In the case of inheritance tax, each beneficiary may have to pay a different amount, depending on how much is inherited. Some states, including Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania, still have inheritance taxes.

California residents do not need to worry about a state estate or inheritance tax, which is a tax that is levied on people who either own property in the state where they died (estate tax) or inherit property from a resident of a state (inheritance).

Currently, six states levy an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvannia. There are 15 states (plus the District of Columbia) that levy an estate tax: Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Tennessee, Vermont, Washington, and the District of Columbia.

Even though California does not collect an inheritance tax, if you live in California, and inherit property from someone who lived in a state that does levy an inheritance tax, you may get a tax bill for the property that you inherited from the person who lived in that state. You won’t be taxed if you were married to the deceased person, and some states exempt small inheritances. But it’s still a tax bill that you’ll have to pay and that you might not have been expecting.

The only ‘death tax’ that California residents need to worry about is the federal estate tax, and that tax falls on the estate of the person who died, not on the people who inherit that property. There is an exemption of $5 million, which is indexed to inflation and is currently $5,450,000, and only people who die with an estate larger than that exemption will have to pay estate tax. It is estimated that only the richest .14% of Americans will be subject to the estate tax, or only two out of every 1,000 people who die.

If someone dies in California with less than the exemption amount, their estate doesn’t owe any federal estate tax, and there is no California inheritance tax. The heirs and beneficiaries inherit the property free of tax. They don’t pay income tax on it, either, because inherited property is not ordinary income. The only exception to this are inherited retirement accounts, which are subject to income tax as the assets are withdrawn.

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