What are the 4 Major Types of Taxes to Consider in Estate Planning?

It is often said that there are only 2 certainties in life: death and taxes. True or not, estate planning is still an important step in managing at least 2 of life’s certainties. Estate planning is the process of ensuring that your assets and belongings are passed to those you desire to receive them. Usually that means passing assets to family members and friends. Sometimes, it might include an endowment for a charity. It is doubtful that anyone has ever wanted to maximize the portion that is given to the government for taxes though. As such, an important part of estate planning is reducing the amount of taxes that will be due, in turn maximizing the gift to your loved ones.

There are a few myths surrounding estate taxes, and it is important to dispel the misinformation regarding them before beginning estate planning. First, estate taxes are not just for the rich. In 2023, the estate and gift tax exemption is $12,920,000, but there are other taxes that can chip away at your estate without proper planning. Second, estate planning is not just for those who have retired. Putting a plan in place early can possibly reduce future taxes, and then plans should be reviewed and tweaked later. But what are these taxes, and how do they play into an estate plan?

4 types of taxes to consider in estate planning are gift tax, estate tax, generation skipping transfer tax and capital gains tax. Each can have an impact on estate planning and the amount that you have to pass on to your loved ones. With smart planning, however, an estate plan can also help possibly reduce them. Other taxes may also be in play depending on your situation.

Gift Tax

As the name implies, this tax applies to “gifts” that you give to people (other than your spouse or charities). The gift tax only applies if the amount you give is over your annual gift exclusion ($17,000 per person in 2023) or if you have exhausted your total lifetime gift exemption ($12,920,000 in 2023). When giving a gift, any amount of your annual gift exclusion is applied to your estate and gift tax exemption. The estate and gift tax exemption is a unified credit, which means any amount of gift exemption you use decreases the amount of estate exemption left at your death. For estate planning purposes, a common technique is to give amounts equal to your annual gift exclusion each year to those you intend to benefit. This maximizes the exclusion amount while reducing your overall estate and retaining your estate and gift tax exemption for future use.

Gneration Skipping Transfer Tax

Each individual has a generation skipping tax (GST) exemption of $12,920,000 for 2023. This is a complicated tax but it generally applies to any gifts to relatives two (or more) generations removed from you, such as grandparent to grandchild. It also applies to beneficiaries that are not related to you but are 37.5 or more years younger than you. Each individual also has a $17,000 annual GST exclusion. Making annual gifts up to the exclusion is an easy way to possibly avoid GST tax.

Estate Tax

The estate tax is applied to property that is passed from you to your beneficiaries at your death. In determining who to pass assets to, you should also consider how your estate will pay the estate tax. If the inherited assets are not liquid, such as a business or unique real estate property, it will make it difficult for your estate to pay the estate tax because it is not a simple case of selling the asset for money to cover the tax. Consider what liquidity exists so the estate tax can be paid while allowing your beneficiaries to keep the business or real estate, rather than needing to sell the asset in order to pay the estate tax.

Capital Gains Tax

These taxes are paid on the sale of assets and apply to the difference between what you purchased the asset for and what you sell it for. In most instances, the decedent’s assets get an adjustment to basis at the decedent’s death. This adjustment in basis typically eliminates any capital gains due by reason of the decedent’s death.

Are you ready to create an estate plan that maximizes the amount your loved ones get? Have an estate plan, but need a review or update? Call the estate planning lawyers at Brown Law Firm, LLC at (303) 339-3750.