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How to Avoid Inheritance Tax

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Authored by Geoff Vaughan in Taxes
Published on 03-02-2009

One of the most debated issues in politics lately has been the tax the U.S. places on inheritances. More commonly referred to as the “death tax” by its critics, this levy is a tax on the “gross estate” of an individual that passes away, as it is transferred to his or her heirs. The value of this gross estate may or may not be equal to the amount in the probate estate, as there are certain things such as some life insurance proceeds and certain title to property that may not be owned by the decedent while alive, but are taxable after death. While there is generally an exclusion amount of one million dollars or more below, which taxes are not due on the estate (the amount of this exclusion varies from year to year depending on the laws in place), many people who end up owing this tax feel it very hard to part with some of the money that their benefactor worked for, and thus seek out ways to avoid the tax. And while avoiding paying taxes that are legally owed is in fact illegal and not recommended by the author, the key is to avoid having to owe the taxes in the first place. This takes some planning on the part of the owner of the assets before the time of passing to make it work successfully.

If you’re married, and the full value of your estate passes to your spouse in the event of your death, there is good news: no estate taxes will be owed no matter how large the estate is, if the surviving spouse is a U.S. citizen. If not, a special trust can be established to take advantage of this tax benefit. The bad news is that once the surviving spouse passes away, the entire estate will become taxable, minus any amount that falls under the exemption of that year.

If the decedent is passing the estate onto persons other than a spouse, one very popular way that people use to avoid owing inheritance taxes upon death is to give out tax free gifts to the future heirs while the person is still alive. Currently, this is limited to $11,000 per recipient per year. If you go over this amount, there are gift taxes that will be levied, which would defeat some of the purpose of the gifts. I say “some” of the purpose because one nice benefit of doing things this way is that the person giving the money has a chance to see the recipients enjoy the money while he or she is still alive.

Another method is to use a living trust called a “Revocable Living Trust with an AB Provision.” By placing the money into a trust for the surviving spouse and offspring, the exemption amounts of both spouses are added together when the surviving spouse finally passes away and applied to the balance of the estate as it passes to the children. The surviving spouse has free access to the money in the trust as well, so there are no issues with he or she having to scratch out a survival just so the kids can enjoy the inheritance and pay less taxes on it.

There are other ways to do this as well, including other types of trusts that can be set up for various purposes. Whichever method is employed, you can be assured that there are ways to keep the family money in the family (at least most of it) when a couple passes away.

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