Maybe you’ve spent your life earning and amassing wealth or maybe you inherited wealth and helped it grow, either way you want to pass that wealth on to your own dependents. You have friends who have shared horror tales about taxes that sucked up huge portions of their legacy wealth before it could get to their kids.
You want to pay your fair share of taxes and not dodge your responsibilities, but you want to be smart and ensure as much of your legacy wealth makes it to your descendants as possible. There are strategies and ways to keep as much of your amassed wealth together as possible for your future descendants. Here are some things to consider.
What Is Legacy Wealth?
You might also hear legacy wealth referred to as generational wealth. Legacy wealth is large sums of money that moves from one generation of a family to the next largely intact. In some cases, the wealth grows from one generation to the next, while in others it can shrink. One of the reasons it can shrink is estate taxes. Without careful planning, your heirs will pay an estate tax to the Internal Revenue Service (IRS),
The other biggest cause of shrinkage is the number of descendants. For instance, say your great-grandfather amassed a fortune and split it evenly between his two children. Your grandparents who had only half of the original fortune split it evenly between their two children. Your parents who received a quarter of the original fortune passed an eighth each to you and your sibling. It’s easy to see how generational wealth could shrink this way.
While you can’t do anything about shrinkage due to the number of descendants, you can be proactive about sheltering money from estate taxes. There are legal steps you can take now to protect your legacy wealth and pass more of it on to your descendants.
What Is the Estate Tax?
After your death, the IRS charges an estate tax on your qualified assets if it’s valued above a certain dollar amount. In 2020, if your estate is valued at or above $11,580,000, then your estate owes taxes. The tax rate can be up to as much as 40 percent. Does your estate meet the qualifications for the estate tax?
The first consideration is the value of everything you owned or had certain interests in at the time of your death. This includes:
- Real estate
When these items are assigned a value, the IRS requires that the estate use the fair market value and not the price originally paid for the item. For example, if you purchased a vacation home in Florida 30 years ago for $25,000, and it’s worth a million dollars now, you value it at the million-dollar price. The value of these assets gives you the gross estate.
Now, there are certain items that you can deduct from that total. This includes debts, such as mortgages and loans. You can also deduct estate administration expenses and the property that goes to a surviving spouse and qualified charities. When you subtract the allowed deductions from the gross estate, you find the net estate.
The Last Step
However, there is one final step. Starting in 1977, gifts that exceeded a certain amount were taxable. The dollar amount limit varied from year to year. In 2020, the limit is $15,000 for gifts per person. For example, if you give your daughter a new car that’s valued at $25,000, then $10,000 of that amount is taxable. Each year, you’re required to file paperwork on all gifts that year that exceeded the listed amount.
You weren’t required to pay taxes on them each year. The IRS wanted you to report them each year. Now, your estate must add the gifts that were over the amount to the value of your estate. At this point, if you’re over the current threshold for estate taxes, then you pay taxes on anything above the threshold.
For example, it’s 2020, and your estate has a net value of $50 million. You deduct the $11,580,000 from the $50 million for a taxable total of $38,420,00. If the tax rate is 40 percent, then your tax bill is $15,368,000. And that’s a lot of your legacy wealth going to the IRS.
There are ways to legally lower your estate taxes and keep your wealth intact for your descendants.
While $15,000 a year may not seem like a lot, it can add up. Not only can you give your children that amount each year, but you can also give that amount to their spouses too. You can also give the same amount to your grandchildren and great-grandchildren.
However, gifts to grandchildren tend to fall under the generation-skipping transfer tax (GST). This is a tax on a gift given to anyone 37.5 years younger than you. You can still give them the full $15,000 before you’re required to pay taxes on it through your estate. You can use gifts to protect a significant amount of your legacy wealth, especially if you start early.
For example, if you have two children with two spouses, four grandchildren, and eight grandchildren, you can gift $15,000 times 16 people for a yearly total of $240,000. Now, if you do this for 10 years before your death, you’ll gift 2.4 million dollars. The 40 percent tax on this money would have been $960,000. Now, that’s a large saving.
Irrevocable Life Insurance Trust
It isn’t enough to buy life insurance. The funds from the policy can still be taxable with your estate. However, you can set up an irrevocable life insurance trust with a family member as the beneficiary. Once you set up this trust, you lose control over making changes to the insurance policy without the consent of the beneficiary.
For all intents and purposes, you are setting up a trust, and you’re giving the benefits to someone else. If this idea appeals to you, it’s better to create this life insurance trust immediately. If you pass away before three years passes after creating the trust, the life insurance benefits might still be taxable. Of course, if you have multiple descendants you want to pass wealth on to, then you can create multiple trusts.
It’s easy to see how the payouts from the life insurance policies will move wealth to your children. However, it isn’t so easy to see how it’s moving the wealth you currently have to your kids. Actually, the monthly premiums on these policies will come out of your current wealth, and when the policy pays out, it goes to your descendants.
Family Limited Partnership
If there’s a family business that you own or properties in your name that you want to pass on to your kids, a family limited partnership is one way to legally transfer without the business or property becoming part of your estate. Usually, you do this by creating a general partnership and make your children or any other beneficiaries limited partners.
During your lifetime, you remain in control of your business and properties. However, your partners own a portion of your company or properties. This will reduce the size of your estate and help you keep more of your legacy wealth intact for your descendants.
Qualified Personal Residence Trust
Another way to reduce the size and assets in your estate is to create a Qualified Personal Residence Trust (QPRT). The QPRT moves the ownership of your property from your estate to your trust. During the period of the trust, you can reside in the property without paying rent or other considerations to the trust.
By placing the property into a trust, you freeze increasing market values and can avoid paying gift taxes if the amount doesn’t exceed your lifetime limit. At the end of the term, the property goes to the beneficiary of the trust.
Irrevocable Living Trust
An irrevocable trust allows you to transfer cash, property, and other real property into a trust for your beneficiaries. Although once these assets are in the trust, you can no longer be modified, amended, or terminated without the express permission of the trust’s administrator. You give up all your legal rights and say in how these benefits are managed from the start of the trust.
With an irrevocable living trust, you’re removing assets from your estate and placing them into the trust. After the property or monies transfers into the trust, you can no longer expand any type of ownership over them. All the decisions are made by the administrator, who distributes assets to the beneficiaries through the trust. This is a complicated legal entity, and you should seek help from professionals.
It is possible to limit the tax liabilities of your estate. However, you need to be careful to ensure everything you do is legal and above board. At Silver Tax Group, we have the experience to help protect your legacy wealth for your descendants and keep taxes to a minimum. We’re ready to partner with you to reduce the size of your taxable estate, so contact us today to learn more.