What comes to mind when you think about taxes?
Most people immediately think of income tax (the annual payment we make to the government based on our earnings.) However, there’s a whole other realm of taxation that you might have heard scary things about: estate taxes. To make it less scary, let’s talk about a few terms that may come up. Understanding these terms can help demystify the estate tax landscape. It can also help make you more confident so you can make informed decisions about your financial future!
What Does It All Mean?
Many people worry that when they die, “iwe’ll lose it all to the government.” I’m here to tell you, for most of us, this is not the problem you may think it is. Here are some terms to understand so you’ll be more confident when thinking about estate planning issues.
Estate Taxes
The federal government and some states assess taxes on the property you leave behind upon your death.
Estate Tax Exemption
Now, here’s where things get interesting. Not all estates will need to pay federal estate tax because there is a federal estate tax exemption. An exemption excludes from taxation a portion of the value of an estate. The estate tax exemption is like a magical shield that protects a portion of your assets from taxes after you’re gone.
In 2024 this exemption is $13.61 million dollars per person or $27.22 million for a married couple. If your estate is worth less than this, you don’t have to worry about your estate paying the estate tax. If you do have a taxable estate, the tax is only imposed on the part of the estate over the exemption amount.
Because of the current high value of the exemption, you will rarely owe federal estate tax. In fact in 2020 there were just under 3.4 million deaths in the United States and only 1,290 estates owed estate tax. That’s less than .04%!
Gift Tax
The federal government also imposes a tax on gifts. Did you know that? However, each year there also is an Annual Gift Tax Exclusion — In 2024 the exclusion amount is $18,000 for gifts to any individual. That’s pretty generous gift-giving! What happens if you give a gift worth more than $18,000? You can file a gift tax return and use part of your estate tax exemption to cover the gift.
How does the gift tax and annual exclusion amount relate to estate planning? Think of it as a way to proactively transfer some of your estate to your loved ones. If you can spare the assets, this is a great way to have a direct impact on a family member’s quality of life (helping them with something like the purchase of a car, down payment on a house, or tuition for a grandchild) and you’re there to see it. It also lets you see how people handle their money and can guide your other estate planning decisions.
Generation-Skipping Tax
What happens when your kids are set financially and you want to leave your estate to your grandkids? At one point well-off families thought they could avoid some taxes by skipping their children and leaving the estate to the following generation.
The federal government did not like missing out on the tax from one generational transfer, so they created the Generation-Skipping Tax. If your estate skips a generation not only may it be subject to regular estate tax (if the value is high enough) it also may be subject to an additional 40% tax as a penalty for skipping a generation! Fortunately, there’s an exclusion amount that mirrors the estate tax exclusion, so the estate would have to be quite substantial for this to be a problem.
Basis
Basis is generally the cost of an asset when you get it. For example, if your parents bought a house in 1970 for $23,000. That is the basis for their house. If they sold it, their capital gain would be based on that value.
Step-Up in Basis
Now imagine you inherited that house in 2022. It might have been worth $454,000! Luckily, when you inherit an asset you get a step-up in basis to the date of death value. So instead of having a capital gain of $431,000, the basis is set at $454,000. If you sell it right away, you likely will have no taxable capital gains, giving you a huge tax saving.
What Should You Watch For Regarding Estate Taxes?
There is one possible cloud on the horizon. The current federal estate tax exemption is due in part to the Tax Cuts and Jobs Act (TCJA) of 2017. Those provisions are set to expire at the end of 2025 unless Congress passes a statute to extend it. What happens if it expires? The exemption levels return to their pre-2018 levels as adjusted for inflation. This means the exemptions will be roughly cut in half.
For most people, this will still be more than enough for their estate to pass without federal estate tax. For some though whose estates are currently between $6 and $13 million, it may be time to consider some more sophisticated estate planning to reduce the potential for estate taxes.
How Schroeder Larsen Law Can Help You!
Taxes are definitely complex, but when you take time to understand them — you’re taking an important step towards financial empowerment! From income tax to estate taxes — navigating the difficulties of the tax code can help you maximize savings, make strategic decisions, and minimize liabilities.
At Schroeder Larsen Law, I can help you identify your potential for a taxable estate, and provide advice to minimize that potential impact. You will always get solutions tailored to your situation. I’m here to help you and work closely with your tax advisor to understand your unique goals. We’ll then develop a personalized plan that addresses your needs and protects your wealth for the future.
Click the button below to schedule a consultation today, and let’s secure your financial future!