While the federal estate tax was originally repealed in 2010, it came back retroactively on January 1, 2010 with a $5,000,000 exemption that was also in effect in 2011 and then increased to $5,120,000 in 2012. On January 1, 2013 the estate tax exemption was supposed to decrease to $1,000,000, but on January 2, 2013 President Obama signed the American Taxpayer Relief Act into law, which has made permanent changes to the federal estate tax laws. For detailed information about the laws governing estate taxes, gift taxes and generation skipping transfer taxes in various years, refer to All You Need to Know About Estate Taxes.
Aside from federal estate taxes, many states also assess estate taxes, and a few states assess inheritance taxes. For people whose estates will be taxable at the state and/or federal level, they have several options to reduce their estate tax bill.
1. Spend their assets.This is the quickest and easiest way to reduce the value of an estate. The obvious problem with this approach is that no one knows how long they will live and how much money they will need. Thus, drastic spending is only an option for people who have accumulated a significant amount of wealth and aren't afraid of running out of money before they die.
2. Gift their assets directly to family members or not-for-profit organizations.This option will only work well for those who feel comfortable giving away part of their estate while they're still alive. As mentioned above, often times people are resistant to give anything away because they're afraid they'll run out of money before they die and once they decide to give it away, they can't easily get it back. As with spending it, gifting directly to family members or charitable or other not-for-profit organizations will only work well for those who aren't afraid of running out of money.
3. Create a foundational estate plan.For married couples, including same sex married couples, the use of basic AB Trusts or ABC Trusts in their estate plan can significantly reduce or even eliminate both federal and state estate taxes assessed against their estates. (Note: Beginning in 2011, the federal estate tax exemption has been made "portable" between married couples, which has eliminated the need for AB Trust or ABC Trust planning for many couples. See more on this below in #4 below.) For both married couples and individuals, the use of an Irrevocable Life Insurance Trust ("ILIT" for short) to hold and own life insurance offers two benefits: (1) life insurance owned by an ILIT will remove the value of the insurance proceeds from the insured's taxable estate; and (2) the insurance proceeds can provide immediate cash to pay bills, expenses and taxes.
4. Get married.
As mentioned above, beginning in 2011 the federal estate tax exemption has been made "portable" between married couples, which now includes same sex married couples. This means that if one spouse dies in 2011 or a later year and his or her federal estate tax exemption isn't entirely needed to avoid estate taxes, then the unused portion can be added to the surviving spouse's exemption. This, in essence, will allow married couples to pass on up to $10,000,000+ free from federal estate taxes. So, if you're in a committed relationship but not legally married, then consider marriage as a way to minimize estate taxes. But some couples need to be cautious about eliminating AB Trust or ABC Trust planning from their estate plans. For example, if you and your spouse have different final beneficiaries (in other words, you each have your own children or other beneficiaries who you want to inherit your separate estates), then you and your spouse cannot rely on portability to minimize federal estate taxes in both estates. In addition, to date Hawaii is the only state that collects a state estate tax that has adopted portability, so AB Trust or ABC Trust planning may still be required to plan for state estate taxes in some states.
5. Use advanced estate planning techniques.There are a variety of advanced planning options that are designed to reduce estate taxes and yet allow you to maintain an income stream for life, which should alleviate the fear of running out of money before you die. Gifting through a Family Limited Liability Company offers both estate tax reduction and asset protection. Married couples can take advantage of annual exclusion gifts and their lifetime gift tax exemptions by creating Spousal Lifetime Access Trusts, or "SLATs," for the benefit of each other. Creating a charitable trust, such as a Charitable Remainder Trust, gives you a charitable income tax deduction when the trust is funded and gives your estate a charitable estate tax deduction after you die. A Qualified Personal Residence Trust allows you to live in your home for a period of years and then the home will pass to your heirs at a reduced value for estate and gift tax purposes after the period ends.
6. Move to a new state.
If you currently live in one of the following states that collects a state estate tax and/or an inheritance tax - Connecticut, Delaware, District of Columbia, Hawaii, Illinois, Iowa, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Jersey, New York, Oregon, Pennsylvania, Rhode Island, Tennessee, Vermont or Washington - then consider moving to a state that doesn't collect an estate and/or inheritance tax. While this may seem to be an extreme option, the bottom line is that even for a modest estate it can mean saving thousands of dollars in death taxes that will stay in the family instead of going to the government. To learn more about state estate taxes, refer to the State Estate Tax and Exemption Chart. To learn more about state inheritance taxes, refer to the State Inheritance Tax Chart.