An estate tax is a tax on the transfer of assets from a deceased person to their heirs. The federal estate tax only applies if the estate exceeds a certain value, which changes periodically. As of 2024, estates valued over approximately $13 million (for individuals) are subject to federal estate tax. States also have their own estate or inheritance taxes, with thresholds that can be much lower.

Goal: The goal of tax-savvy estate planning is to reduce the taxable value of your estate, either by reducing the value of the assets subject to tax or by using various exemptions and strategies to ensure more wealth passes tax-free to your heirs.

A trust is a legal arrangement where a third party (a trustee) holds and manages assets on behalf of beneficiaries. Certain types of trusts, such as revocable living trusts or irrevocable trusts, can be key in reducing estate taxes.

• Revocable Living Trust: While it doesn’t offer direct tax savings (since you still control the assets), it allows for a smoother transfer of assets upon death, avoiding probate, which can reduce the time and cost of settling your estate.
• Irrevocable Trusts: By transferring assets into an irrevocable trust, you effectively remove those assets from your estate, reducing the value that will be taxed. This can significantly lower your estate tax liability. However, once assets are placed in an irrevocable trust, you no longer control them.

One of the most effective ways to reduce estate taxes is to give away assets before you pass. The annual gift tax exclusion allows you to gift up to a certain amount each year (for 2024, this amount is $17,000 per recipient) without incurring gift tax. Gifts above this amount may count against your lifetime estate tax exemption, but making gifts during your lifetime can reduce the size of your taxable estate and lower potential estate taxes.

• Lifetime Exemption: The federal government also allows individuals to gift up to $13 million during their lifetime without paying estate or gift taxes (for 2024). Gifting is often a great way to pass on wealth without triggering taxes if done wisely over time.

Life insurance can play a significant role in tax-savvy estate planning. The death benefit from a life insurance policy is generally not subject to income tax. However, if the policy is owned by your estate, the proceeds could be included in your taxable estate, potentially increasing your estate tax liability.

To avoid this, you can have the policy owned by a life insurance trust. The trust owns the policy, and the proceeds pass directly to your beneficiaries without being included in your estate for tax purposes.

Charitable donations can be a powerful way to reduce the size of your taxable estate. When you leave a portion of your estate to charity, that portion is generally not subject to estate taxes. Additionally, charitable remainder trusts (CRTs) can provide tax deductions while ensuring you receive income during your lifetime, with the remainder going to a charity upon your death.

• Donor-Advised Funds: Another way to reduce estate taxes is by donating to a donor-advised fund (DAF), where you can make tax-deductible contributions during your lifetime and then recommend charitable grants over time.

Certain accounts, such as IRAs, 401(k)s, and other retirement accounts, allow your investments to grow tax-deferred. When planning your estate, it’s important to consider how the tax burden on these accounts will be handled by your beneficiaries. Heirs of traditional retirement accounts will need to pay income tax on distributions, and there may be strategies to minimize this tax, such as stretch IRAs or Roth IRA conversions (where the tax is paid upfront).

When you pass assets to heirs, they generally receive a step-up in basis, meaning that the value of the asset is “stepped up” to its current market value at the time of your death. This can significantly reduce the capital gains taxes that your beneficiaries would otherwise owe if they sold the asset. For example, if you bought a property for $100,000 and it’s worth $300,000 at the time of your death, your heir inherits it with a basis of $300,000, so they would only pay taxes on any appreciation above that amount when they sell.

A Family Limited Partnership (FLP) allows you to transfer ownership of assets (such as real estate or business interests) to family members while maintaining control. This strategy often allows you to reduce the value of your estate through valuation discounts, since family members don’t have full control or marketability of the assets. This can be particularly useful for large estates or closely-held businesses.

Ensure that your beneficiary designations are up to date on accounts like retirement plans, life insurance, and bank accounts. These designations bypass probate, making the transfer of assets smoother and quicker. Furthermore, correctly allocating assets to beneficiaries may allow for better tax treatment. For example, naming a spouse as a beneficiary may provide tax advantages for them, whereas naming a trust might be beneficial for minor children.