Estate taxes: What are they and how to avoid them

This should not come as much of a surprise to you, but Texas is a great place to live if you don’t like paying taxes. Since there aren’t many people out there who do like paying taxes, I will assume that you would count yourself among those who are happy to live in a low-tax burden state like Texas. Not only are taxes low here but the cost of living is, too. When compared to other states in the United States, Texas is a relatively inexpensive place to live all things considered. 

Probably the most well-known reason why the tax burden on Texans is so low is that we have no state income tax. This is a huge help to families especially in a time like we are going through right now while inflation is skyrocketing, and investments have not seen their usual, steady growth that they have had since the recession of 2008. When the dollar doesn’t go as far as it used to, it can be reassuring to know that at least you don’t have to pay a state income tax on top of your federal income taxes which we pay to the IRS each April. 

Even though Texas doesn’t hang your upside down by your ankles when it comes to trying to siphon off tax dollars, the federal government will see to it that you pay your share of taxes, without a doubt. To that end, when we discuss subjects like estate and end-of-life planning, estate taxes matter a great deal. Texas does not have an estate tax but your estate may owe a tax when you pass away. Since this is a subject that won’t impact you but could impact your children and spouse you will want to learn as much as you can to minimize the hardship incurred on behalf of your estate when it comes to having to pay estate taxes. 

What are estate taxes? How can you reduce your tax burden on estate taxes? Is there a difference between inheritance taxes and estate taxes? These are all great questions to ask yourself currently. Fortunately, we have the answers that you need to be guided properly in your estate planning. In today’s blog post from the Law Office of Bryan Fagan, we are going to walk through this subject with you so that you know the subject to guide you in your estate planning endeavors. 

Questions about what you have read? Contact the Law Office of Bryan Fagan today for a free-of-charge consultation with our experienced estate planning attorneys. We can schedule you for an in-person, video, or telephone meeting with an attorney to go over your specific circumstances and provide you with honest feedback. 

The basics of what an estate tax is

A tax on your ability to transfer property at your death is what an estate tax is. When you pass away your assets are going to be assessed and counted in terms of dollars. The value of your property at your death is the value that will be counted towards your estate for tax purposes. A percentage of your estate will then be paid in taxes. When you hear people on television talk about a “death tax” this is what he or she is referencing. Many people, somewhat understandably, do not like the idea of being taxed on income and other things while you are alive only to have your estate taxed when you pass away. In this way the federal government taxes you while you are coming and while you are going- literally and figuratively. 

Texas goes easier on its residents than the federal government does at least when it comes to estate taxation. However, even though we are giving our federal government a tough time when it comes to the estate tax that does not mean that most of us will ever have to seriously worry about our estate needing to pay money out to the federal government after we have passed away. The reason for that is only estates worth more than $12 million are liable to pay an estate tax. If your estate is worth less than that number, then the estate will not see money owed to the government upon your passing. 

What is your estate and why does it matter?

Your estate refers to the collection of property (assets) and debts that you own at any point in time. Your estate is always fluid while you are alive because you can accrue debt, purchase property, sell property, etc. When you pass away those changes. At that point, your estate is set in stone. If you have named an executor of your estate in a will then that executor will be in charge of your estate as far as executing the will, notifying creditors, and distributing property to your beneficiaries. If you die without a will then someone, your spouse, or another person most likely, will need to handle matters with paying creditors, notifying heirs of your passing, and other estate-related matters. 

The value of your estate will need to be calculated before any estate tax can be determined. At your death, all your assets can be added up to determine your gross estate. Any liabilities like debt would be subtracted to determine your net estate to distribute property. 

We can do some simple math to illustrate this point better. Let’s say a person dies with a gross estate valued at $4 million. That means all their property when added up together comes out to $4 million. When all that person’s liabilities are added up they came out to $500,000. This means that the person’s net estate is worth $3.5 million.

As we talked about earlier, an estate’s net value must exceed roughly $12 million to be subject to the federal estate tax. In 2023 the exact threshold for estate tax purposes is $12,920,000. Obviously in this case there would be no tax liability for this estate. This assumes that there are no gifts that the person made during their life that exceeded the annual exemption amounts for a particular year. 

How can you reduce the likelihood that your estate owes taxes upon your passing?

Decreasing your estate’s exposure to taxes when you die is a function of the net value of your estate. This is a narrow issue given that the truth of the matter is that most of us are not going to pass away with an estate valued at over $12 million. Some of us will, but statistically, it is not likely. However, it is still worth discussing since the estate tax is something that can help teach lessons otherwise about good estate planning. Taxes are also something that can eat away at the hard work that led to your building up a substantial estate. Minimizing tax exposure of any kind is a good thing and a good lesson to learn.

Fortunately, there are a handful of ways for you to minimize the estate tax exposure that you have. The most direct, and possibly the most enjoyable, way to do this is to simply spend as much of the money as you need to to get your estate below that $12 million and change threshold. Buying things like vacations where the only thing that you take away from the purchase are memories would be ideal. Purchasing something inherently valuable is more like an investment and may not decrease the value of your estate all that much.

On the other hand, instead of spending money on yourself or those in your immediate family, you can always donate as much of that money as you can. Think about your church, charities, families, individuals, or anyone else that you believe is deserving of financial support. You can try to contact that person and discuss how you would like to gift them assets. Remember that there is a gift tax that will apply here so this is something that you may want to talk with a tax professional about before getting involved with. 

You can also establish a trust to avoid estate taxes. Examples of different trusts that you could choose to establish are generation-skipping trusts and charitable trusts. The trust that you create would be used to hold assets for your beneficiaries and heirs and would allow your estate to not have to pay taxes on those assets when you pass away. One of the estate planning attorneys with the Law Office of Bryan Fagan can help you create a trust plan that works for your family. Irrevocable trusts cannot be changed or otherwise rescinded during your life. A revocable trust can be changed whenever you see fit, however. 

Life insurance can be a mechanism that you use to avoid estate taxes. There are two, basic types of life insurance: term and whole-life policies. In a term life insurance policy, you would pay a yearly premium for a face-value insurance policy that pays out when you die. You can name a beneficiary in the policy who would need a death certificate to receive the money on the policy. You can find out more about the various types of policies from a financial professional or life insurance agent. In any event, this money passes to the beneficiary of the policy without estate taxes or probate being involved. 

There is more to taxes than reducing the amount you need to pay in taxes

Estate planning is not only about limiting how much your estate may need to pay the government in taxes when you pass away. Additionally, paying taxes while you are alive is not something anyone looks forward to. Estate planning goes beyond limiting your tax liability, however. Ultimately, how your wealth can be delivered to your family and other beneficiaries when you pass away is what your legacy will be. How do you want to be remembered and what impact do you want your wealth to have on others? 

Do not wait to prepare for end-of-life scenarios and estate planning. Creating a will, for example, is a great way for you to direct how your property should be distributed out of your estate and can also be a helpful way to name guardians for your children should you and your spouse both pass away at the same time. Keep in mind that creating a will puts you in the driver’s seat when it comes to controlling how your property will be handled after you pass away. The alternative to this arrangement would be to have the government (a probate court judge) make these determinations for you. After working as hard as you have to build wealth and assets it does not make sense to allow another person, unaware of your goals and preferences, to determine where your property ends up.

A key part of your will is the naming of an executor. An executor is a person that you choose to execute your plan as far as property distribution is concerned. You should name an executor who is trustworthy, responsible, and capable of following your instructions. Another tip for estate planning matters related to a will would be to make sure that your family is aware of what is contained in the will. Do not leave it up to the executor to read the will or tell your family for you. Rather, you can and should communicate how property is distributed in your will so that there are no surprises when you pass away. This is also a key part of your legacy and what you are leaving to your family. 

Retirement accounts are an important part of wealth building. Not only can you maximize wealth building through retirement accounts, but you can also plan for the future, minimize taxes and avoid probate in all in one package. Retirement accounts allow you to name a beneficiary so that these accounts can pass to the beneficiary after you pass away without having to go through probate first. In most situations even if you “will” a retirement account to someone other than the beneficiary stated in that account, the beneficiary listed in the retirement account will receive the property after your passing. 

How to plan for poor health and sickness

Unfortunately, planning for end-of-life scenarios also involves worst-case scenarios. If you were to become incapacitated or otherwise unable to communicate with your family, this puts you in a difficult spot. Being able to direct the financial accounts and handle money generally is a major part of being an independent, autonomous adult. When you lose the ability to make decisions for yourself and your money another person would need to step in and make those decisions for you. 

However, you can anticipate a situation like this happening and name someone to be able to handle financial matters if you are unable to do so yourself. In a guardianship situation, a court can name someone to be able to make these sorts of decisions for you. However, the reality is that you or your family may need to repeatedly go to court to have a judge sign off on decisions that are being made on your behalf. Not only is this not practical, but it can also cost money. 

A way to avoid this situation is to name a power of attorney for your finances. Someone who knows your situation, is familiar with how you would want financial matters handled, and is above all else trustworthy is the type of person that you should consider naming as your financial power of attorney

Another way to exert some degree of autonomy over your life if you were to become incapacitated is through a medical directive. A medical directive would go into effect if you are unable to make medical decisions for yourself. A power of attorney for healthcare-related decisions can give someone authority to make decisions on your behalf when it comes to your health. Whether you would like extraordinary care to be used and the extent to which you would like lifesaving methods of medicine to be implemented in your case are just a few of the elements that can be contained in a medical directive. 

Whatever your situation, marital status, and family composition are, it makes sense to regularly review your circumstances to determine if your current estate and end-of-life planning matches up with where you are now- physically, emotionally, relationally, and financially. Working with an experienced estate planning attorney is the most efficient way to determine your goals and map out a direct course for achieving those goals with the least amount of time, hassle, and money that needs to be spent. 

Questions about the material contained in today’s blog post? Contact the Law Office of Bryan Fagan

If you have any questions about the material contained in today’s blog post please do not hesitate to contact the Law Office of Bryan Fagan. Our licensed estate planning attorneys offer free-of-charge consultations six days a week in person, over the phone, and via video. These consultations are a great way to learn more about Texas estate planning as well as how your family may be impacted by the filing of a probate case. 

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