Articles for Financial Advisors

Reducing Estate Taxes

Reducing Estate Taxes

Because of the 2013 annual exclusion, each person can gift up to $14,000 a year to one or more donees without having to file a gift tax return and without eating into their lifetime exclusion ($5.25 million for 2013). For example, each year a married couple with 7 grandchildren (or children, friends, neighbors, etc.) could gift as a couple $28,000 per person (7 x $28k = $196k each year). Making gifts of portions of a family business or other business assets like stock options, can significantly reduce or eliminate estate taxes.

Making annual or sporadic gifts whether the client is single or married can significantly reduce the size of an estate over the years, particularly if there are a number of donees (since each can receive $14,000 a year per donor). However, the reality is that many people are afraid to make gifts because: [1] they believe there is a chance they will need to money later, [2] they do not want the kids to think this is something they should expect on a regular basis and/or [3] they do not want the kids to have this money right now (or become dependent on it).
Your client can also use a number of different types of trusts to save on overall estate taxes, depending on circumstances and desires.


Perhaps the only positive thing that can be said about death is that heirs receive a step-up in basis. The step-up applies to all assets inherited except: annuities, qualified retirement accounts and IRAs. This means that it is almost always desirable for your client to hold on to highly appreciated property until it can pass at death. If assets are to be gifted while the client is alive, it is usually best to gift assets that have appreciated little and have limited, or no, appreciation potential (e.g., bank accounts, CDs, bonds, money market funds, annuities and cash). However, if the donee is in a lower bracket than the donor, there can be modest or significant tax savings if the new owner (the donee) sells the gifted asset.
Under federal tax law, the basis of inherited property is adjusted up or down to the market value as of the date of death. Gifts made during life are not entitled to a stepped-up basis. Only transfers at death qualify for this desirable tax treatment.

State Considerations

There are two types of state taxes to consider when making decisions about how to leave property: inheritance taxes and estate taxes. Inheritance taxes are imposed on the people who receive the property (beneficiaries or heirs), rather than on the estate itself. Typically, beneficiaries are divided into different classes, such as “Class A: Husband or Wife,” “Class B: Immediate Family,” and “Class C: All Others.” Each class receives different tax exemptions and is taxed at a different rate. Generally, the highest exemption and lowest rate goes to spouses, or “Class A.” For example, Nebraska imposes a 15% inheritance tax rate on $25,000 left to a friend, but only 1% if it’s left to your child. Many states impose no inheritance tax at all on property left to a surviving spouse.
As mentioned earlier, residents of a c/p state have a huge advantage over those domiciled in a common law state: in a c/p state, when either spouse dies, all c/p gets a step-up in basis (even though there is a surviving spouse). In common law states, only the property owned by a deceased spouse receives a stepped-up basis. In a common law state, no property of a surviving spouse receives a stepped-up basis, even if that property was held in shared ownership with the deceased spouse.
States that impose estate or inheritance taxes on residents do so on everyone domiciled in the state. Domicile means the state where you have your permanent residence, where you intend to make your home. Generally, it is clear where domicile is: it is the state where you live most of the time, work, own a home, and vote.

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