Like many people, one of the primary goals of your estate plan is to ensure that your loved ones are well provided for after you are gone. You likely worked hard all your life, saved wisely, and invested prudently in the hope of being able to pass down a decent sized estate to your loved ones. Naturally, you would not want to see the value of your estate diminished after it is passed down. Consequently, you may be concerned that your loved ones will have to pay an inheritance tax on the gifts you leave them. While your concern is certainly a valid one, one of the purposes of creating a comprehensive estate plan is to reduce any potential tax liabilities your estate could occur during the transfer of wealth. The reason for this is that almost all tax consequences stemming from the transfer of wealth occur at the time of transfer, meaning the recipient of the gift does not have to pay taxes on the gift.
Federal Gift and Estate Tax
In the United States, the value of the estate of a decedent, including the value of any gifts made during the decedent’s lifetime, is potentially subject to federal gift and estate tax. This tax, if applicable, must be paid during the probate of the estate and before any assets are transferred to the intended beneficiaries or legal heirs of the estate. Each taxpayer, however, is entitled to exempt up to the lifetime exemption limit which was set at $5 million in the American Taxpayer Relief Act (ATRA) of 2012. The lifetime exemption is also adjusted annually for inflation, putting it at $5.45 million for 2016. The value of assets that exceed the lifetime exemption limit are then taxed at the rate of 40 percent. By way of example, let’s assume that you died in 2016, leaving behind an estate valued at $6 million. Assume further that you made gifts during your lifetime valued at $2 million. You then have $8 million in assets subject to federal gift and estate tax. After your $5.45 million exemption your estate is left with $2.55 million subject to the tax. Your estate would owe $1.02 million in federal gift and estate taxes ($2.55 million x 0.40 = $1.02 million). The tax liability would have to be paid out of estate assets prior to any assets being transferred out of the estate. Therefore, by the time your loved ones receive gifts you made to them in your estate plan all federal gift and estate tax will already have been paid.
Illinois Estate Tax
Individual states may also impose an estate tax. The State of Illinois is one state that does have a state estate tax. Like its federal counterpart, only estates valued above a certain limit are subject to the tax. Currently, estates valued at less than $4 million are exempt from the Illinois estate tax. This means that an estate that evades federal gift and estate tax could still face estate tax liability at the state level. Again, any Illinois estate tax due must be paid out of estate assets before remaining assets are transferred out of the estate to the intended beneficiaries or heirs of the estate, meaning any tax due has already been paid by the time your loved ones receive assets from your estate.
Other Tax Considerations
Although your loved ones will not be required to pay an inheritance tax, or estate tax, on the assets you leave them in your estate plan, there are some additional tax considerations you may wish to consider when making gifts in your estate plan. Capital gains tax and personal income taxes, for example, may both be affected as a result of gifts you make in your estate plan.
Tax Avoidance in Your Estate Plan
If you are fortunate enough to have an estate that could be subject to federal and/or state estate taxes it is in your best interest to include tax avoidance strategies in your comprehensive estate plan. By planning early on to avoid estate tax liability you may be able to avoid paying some, or all, of the tax.
If you have additional questions or concerns about the impact of federal or state estate tax on your estate plan, contact the experienced Illinois estate planning attorneys at Nash Bean Ford & Brown, LLP by calling 309-944-2188 to schedule your appointment today.