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What are Estate Taxes?
Estate taxes, also known as the death tax, are levied on estates of recently deceased individuals before money or other property is disbursed to beneficiaries of the estate. This tax applies to estates worth a specified amount that varies by district. The taxable estate is typically the fair market value of the estate as it stands on the day of the owner’s death minus deductions and an exemption amount.
Who is Subject to Estate Taxes?
Estate taxes primarily target larger estates and serve two purposes: to generate revenue for the state and to attempt to mitigate wealth disparities. Some states have no estate tax at all. Other states have varying exemption thresholds that are structured progressively, beginning at 13% and reaching 16% for larger estates. For 2024, the exemption threshold in Minnesota is $3 million, which means that estates valued at less than this amount are not subject to estate taxes. Even if a state does not have an estate tax, it’s important to note, that there is a federal estate tax that affects large estates.
How Can Trusts Help Minimize Estate Taxes?
The main purpose of a trust is to manage asset distribution after death. A trust is created by transferring property from the owner or grantor to the trustee. The trustee is responsible for holding the property title and managing the property for the beneficiaries. A living trust is created before the death of the grantor, which is the best way to avoid or mitigate probate for the estate and possibly minimize estate taxes.
The two main types of trusts are revocable and irrevocable trusts. A revocable trust allows the grantor to make changes to and remain in control of the assets listed in the trust. These trusts help to avoid the probate process by immediately granting control of assets to the trustee upon the grantor’s death. However, revocable trusts are considered tax-neutral because the consequences for the grantor are generally the same with or without the presence of a trust.
An irrevocable trust cannot be changed, and the grantor relinquishes permanent control of the assets placed within the trust. The trust becomes the owner of the assets. This is an effective way to avoid the probate process and to minimize estate taxes upon the grantor’s death because the property is no longer a part of the estate.
Types of Irrevocable Trusts
- Grantor-Retained Annuity Trusts (GRAT): This type of irrevocable trust allows the grantor to place specific assets in a temporary trust and freeze their value. This removes additional appreciation from the estate and passes the assets on to heirs with minimal estate or gift tax liability.
- Generation-skipping trusts and dynasty trusts: These trusts shelter children and additional generations of heirs from estate taxes. This type of trust allows for the transfer of money to grandchildren or other individuals who are at least 37.5 years younger than the grantor.
- Spendthrift trusts: This trust allows a trustee to decide how and when a beneficiary can use the money when the beneficiary cannot be trusted to make sound financial decisions.
- Special needs trusts or supplemental needs trusts: These trusts allow a person with physical, cognitive, or behavioral needs to obtain financial support without affecting government benefits that are being received, such as Medicaid or Supplemental Security Income.
- Charitable remainder trusts: This trust leaves all leftover assets belonging to the trust to a charity of the grantor’s choosing
How to Set Up an Irrevocable Trust
- First, the grantor creates the trust.
- Next, the grantor names beneficiaries and chooses a third party to act as trustee.
- Then, the grantor transfers assets from his or her control to the trust, thus surrendering ownership rights and ceding control to the trustee. These assets will no longer be considered a part of the grantor’s taxable estate.
How Can Strategic Gifting Help to Minimize Estate Taxes?
The federal government allows each person an annual exclusion amount of $17,000 per individual and $34,000 per couple to gift to any person or persons of their choosing without incurring a gift tax. A couple may choose to gift up to $34,000 per donation per year if written as two separate $17,000 checks, or they can file an IRS 709 form. Effectively utilizing gifting strategies will help reduce the overall value of an estate to a level below the federal or state exclusion threshold.
Contact a family planning attorney at Metropolitan Law Group for more information regarding effective gifting strategies.
How Can Charitable Donations Help to Minimize Estate Taxes?
Charitable donations work similarly to strategic gifting in that they effectively reduce the size of the estate below the exclusion threshold to avoid estate taxes. Donations to qualifying charities will also offer a significant tax advantage that will be beneficial during the life of the estate owner. Utilization of this tool requires adequate documentation and compliance with tax laws to ensure benefits from the tax reductions that are applicable to charitable contributions.
Do I Need an Attorney?
Estate planning can be complicated. When the future of your family is at stake, you deserve help you can count on. Call Metropolitan Law Group today at 612-448-9653or fill out a contact form for a free consultation.
