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Five Things People Don’t Understand About Estate Planning

Written by: FindLaw Staff , Contributing Author
Reviewed by: Catherine Hodder, Esq. , Senior Legal Writer
Last updated March 06, 2024
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During the estate planning process, there are many things to consider, including estate taxes, inheritance tax, gifts, and probate avoidance techniques. This article will provide general information on these areas that are often misunderstood and confusing to people.

Table of Contents

Federal and State Estate Taxes

Avoiding federal estate taxes can be confusing to people who are setting up their estate plans. In reality, very few people need to worry about federal estate taxes. That is because your estate pays federal estate taxes if your estate is $12.92 million or above in 2023.

For married couples, the minimum size of an estate is $25.84 million in 2023. The tax rate for these estates that meet the threshold is currently 18% to 40%. So, if your estate is worth less than these amounts, you do not have to worry about federal estate tax or ways to avoid it. However, if your estate is worth $25.84 million or more, you should seek expert legal and tax advice.

Note that there is no federal estate tax on any property left to a spouse, regardless of the amount (referred to as the marital deduction). Put another way, all property left to a spouse is exempt from estate tax, regardless of the amount.

While the threshold is high to be subject to federal estate tax, it differs among the states. A few states impose an estate tax, and the threshold for a taxable estate is often much lower than the federal threshold. For instance, in Minnesota, the estate tax exemption is three million dollars, and the estate tax rate is 13% to 16%. Be sure to check your state laws for further information on this.

Tax on Inheritance

People who are setting up their estate plan and those who stand to inherit are concerned about inheritance taxes and how they relate to gift and estate taxes.

Let us break down inheritance tax. To inherit means that a person receives property from someone who has died. There is currently no federal inheritance tax, and most states do not tax inheritance. There are a couple of exceptions where taxes might be imposed that involve inherited income from retirement plans and income derived from inherited property.

This means that the person who inherits the money does not have to pay taxes on the amount of the inheritance, subject to the exceptions mentioned above. Contrast this to estate tax, which could be imposed on the estate but not the person who inherited.

Gifts and Taxes

Another area that causes the most confusion is gift tax during a person’s lifetime. While this is a complicated area, there are some basic rules to understand how your gifts affect your estate planning. Note that any tax imposed is on the giver, not the receiver of the gift, as explained below.

A gift, for gift tax purposes, is a gift you give to another while you are alive. Sometimes people give gifts to loved ones to reduce their taxable estate or they do it out of generosity. Again, gift taxes are imposed on the gift giver, not the recipient. In addition, the taxes focus on substantial gifts.

In 2023, there is a $12.92 million lifetime exclusion that you can gift out before you are subject to gift tax. This means that throughout your life, you can gift out $12.92 worth of property without worrying about being taxed on these gifts. Note that gifts to a spouse are not subject to gift tax, regardless of the amount.

In addition, federal law allows you to give a certain number of gifts each year that do not count towards the $12.92 million lifetime exclusion. In 2023, that amount is $17,000.00 per person. This means you can give $17,000.00 to as many different people as you want in 2023 without it counting toward the lifetime exclusion amount of $12.92 million. If you are married, your spouse can do the same. For instance, you could give your niece $17,000.00, and your spouse could give the same niece $17,000.00 this year without the IRS counting this against your exclusion amount.

Let us look at another example. If you give your niece $67,000.00 this year and are not married, this is $50,000.00 more than the yearly exclusion. So, you must report this excess of $50,000.00 to the IRS, who will count it against the $12.92 million lifetime exclusion. If you exceed this $12.92 million in gifts in your lifetime, you will incur gift tax on the amount over $12.92 million. There are many laws and rules on reducing this and managing gifts, so you will need to consult with financial experts if you are considering these types of substantial gifts.

The misconception is that many people think they can only give $17,000.00 per year per person, or they will incur a gift tax. This is inaccurate. You only have to report the amount over $17,000.00 to the IRS, which keeps track of these overage amounts. Most people could exceed this yearly exclusion amount without worrying about federal gift tax.

Taxes involving your estate are complicated and involve federal and state laws. If you have a large and complicated estate, you should contact an estate planning attorney for legal advice, a certified financial planner, or other personal finance experts to assist with complex financial planning and to avoid any estate planning mistakes.

There Are Ways To Avoid Probate

Probate is a court proceeding where a last will and testament is filed with the probate court to be administered according to the terms of the will. A probate proceeding can also occur if you die without a will, called dying intestate. If you die without a will, the probate court will rely on state intestacy laws to determine how to distribute the estate.

Another way a probate proceeding can occur is for a will contest when someone contests the will, contests the executor, or another issue concerning the will. In this case, the probate court will decide the will contest issues and then supervise the distribution of the estate. The probate process is costly and time-consuming, easily taking a year or more to resolve.

Many people have fairly simple estates and can utilize probate avoidance laws and techniques to avoid probate. While the laws in states vary, here are common probate avoidance tools you may be able to use:

  • Living trusts hold property in the trust you control until your death, when your successor trustee transfers assets to your beneficiaries quickly and privately, without a probate proceeding.
  • Pay-on-death designations for bank accounts, stocks, brokerage accounts, and the like allow you to designate the beneficiary on an account document so that upon your death the asset passes directly to the beneficiary without regard to a will or probate.
  • Transfer-on-death deeds for real estate and motor vehicles allow you to designate the beneficiary so that the real estate or motor vehicle can pass directly to the beneficiary upon your death without regard to a will or probate.
  • Life insurance policies go directly to the beneficiary you designate upon your death without regard to a will or probate.
  • Retirement plans and accounts go directly to the beneficiary you designate upon your death, without regard to a will or probate.
  • Brokerage and investment accounts with beneficiary designations will go directly to the beneficiary you designate upon your death without regard to a will or probate.

Keep in mind that not all states provide for all these probate avoidance tools, and even so, you must have a will as part of your estate planning in case something goes awry. For instance, if a beneficiary predeceases the testator and there is no alternate beneficiary, that asset will likely be probated by the terms of the will.

Small Estate Avoidance of Probate

Many states have small estate exceptions to probate or to provide for simplified probate. This means that if the assets in the estate are under a certain dollar amount, those assets can pass to the beneficiary through a simple small estate process. The laws in the states vary widely on how small estates are determined, but most consider a small estate as an estate with a value under a certain dollar amount. For example, let us imagine that a state defines a small estate as one worth $75,000.00 or less and only counts non-probate assets into the calculation amount. Any assets transferred by pay-on-death designation, transfer-on-death designation, joint tenancy, beneficiary, or trust do not count towards the $75,000.00 value. If a person dies with a home with a transfer-on-death designation, a retirement account with designated beneficiaries, and a bank account of $50,000.00 with no pay-on-death designation, then only the bank account counts towards the $75,000.00 limit. In this case, the beneficiary could collect the proceeds using the small estate procedure, avoiding probate.

Creating Your Estate Plan

With some general knowledge about estate tax, inheritance tax, gift tax, and probate avoidance, you should be ready to start your own estate planning. Our state-specific estate planning documents are legal documents that can assist you in making a last will and testament, financial power of attorney, and health care directive, so your loved ones and family members will be taken care of when you pass away. Remember, too, that when significant life events and life changes occur, minor children grow up, and assets change, you will want to revisit your estate plan and update it accordingly.

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