These two forms of taxation relate to transferring wealth from generation to generation but are entirely different. The federal government levies a tax on all estates when the value meets a certain financial threshold. Twelve states and the District of Columbia levy additional estate taxes with separate thresholds. These residents must pay both federal and state estate taxes. In contrast to estate taxes, inheritance taxes apply to inheritable assets and the responsibility of each heir receiving property from an estate.

Estate Tax

This tax is the total value of a decedent’s estate before distribution to beneficiaries. Estate assets may include:

• Real estate
• Investments
• Bank accounts
• Cryptocurrencies
• Businesses
• Digital Assets
• Personal belongings

This federal tax levy is on the estate itself, and the responsibility for its payment typically falls to the estate’s executor (personal representative) using funds from the estate. The tax rate increases with the estate’s value once it exceeds the federal exemption amount. It may be adjusted for qualifying charities and surviving spouses. At the state level, this threshold can vary by jurisdiction.

Under current federal estate tax laws, most Americans won’t die with an estate large enough to trigger the estate tax. Still, fundamental reductions in non-taxable inheritable amounts will occur on January 1, 2026, when the Tax Cuts and Jobs Act expires. Taxable rates will revert to pre-2018 levels (adjusted for inflation), making far more Americans vulnerable to hefty estate taxes without a proper plan. At the state level, protecting assets from excessive estate taxes is also subject to change. Monitoring your state and federal estate tax laws is crucial to complement your estate planning strategy and minimize taxes on your estate.

Inheritance Tax

Inheritance taxes apply to heirs or beneficiaries receiving assets or property from a deceased person’s estate. There is no federal inheritance tax, and inheritance tax rates don’t depend on the size of the estate. The tax calculations relate to the value of the inherited asset and the relationship between the deceased and the beneficiary. For example, surviving spouses and, in some states, domestic partners who register with the state will generally pay nothing.

Inheritance tax is uncommon. Only six states have an inheritance tax in 2023. If you inherit from someone in these six states, you may owe taxes to that state even if you live elsewhere.

Different jurisdictions have varying rules regarding exemptions, deductions, and tax rates depending on the inheritor’s relationship to the deceased. Many immediate family members receive preferential treatment or have lower tax rates than distant relatives or unrelated individuals. Many legal strategies avoid or minimize inheritance taxes by leaving heirs wealth via lifetime gifting, insurance policies, trusts, and more.

How Can You Reduce Estate and Inheritance Taxes?

Estate planning attorneys play a crucial role in helping individuals and families minimize estate and inheritance taxes. They understand tax laws and regulations and can recommend strategies tailored to each individual’s needs.

Trusts

Estate planning attorneys can recommend and establish various trust types, such as revocable living, irrevocable, and charitable trusts. Certain trusts can help minimize estate and inheritance taxes by removing assets from the taxable estate, allowing the grantor to retain control or provide for beneficiaries.

Gifting

An attorney can advise on strategic gifting techniques to transfer assets during their lifetime. Individuals reduce the size of their taxable estate by gifting assets to beneficiaries. Your lawyer can help guide the process of annual gift tax exclusions, lifetime gift tax exemptions, and other strategies like generation-skipping transfer tax (GST) to maximize tax efficiency.

Family Limited Partnerships or LLCs

These entities allow individuals to transfer assets to family members while retaining control. By leveraging discounts, estate planning attorneys can help reduce the taxable value of the transferred assets.

Life Insurance

Lawyers can assess the potential estate tax liability and recommend using life insurance policies to provide liquidity to pay estate taxes. Life insurance proceeds are generally received tax-free and can help cover the tax burden, ensuring that other assets can pass on intact to beneficiaries. Life insurance death benefits can typically pass to beneficiaries without tax consequences.

Asset Titling and Beneficiary Designations

To minimize tax implications, estate planning attorneys can review and recommend appropriate asset titling and beneficiary designations. They can assist in structuring ownership of assets, such as joint tenancy with rights of survivorship, and ensuring proper beneficiary designations for retirement accounts and life insurance policies.

Business Succession Planning

For business owners, estate planning attorneys can devise strategies for transferring business interest to the next generation with minimal tax consequences. They can explore options like family limited partnerships, buy-sell agreements, or employee stock ownership plans (ESOPs) to facilitate a smooth transition while minimizing estate and gift taxes.

Estate Planning Attorneys Help Minimize Tax Consequences

Tax laws and regulations can change over time, so working with an estate planning attorney who stays updated on the latest developments and can provide accurate and relevant advice based on the current legal landscape is essential.

Under current law, most Americans will not have estates large enough to trigger the estate tax. However, income tax avoidance strategies are also important to protect your estate’s value and inheritable assets. Meeting with an estate planning attorney before tax law and regulations changes can minimize the tax burden on your estate and heirs. Contact Rochester Elder Law today to schedule a consultation.