Death Tax Confusion

On Behalf of | Jan 4, 2019 | Estate Planning |

Everyone knows about income taxes.  Some of us are familiar with payroll taxes.  But few have a grip on the arcane world of estate and gift taxes.

Fortunately, most of us can now continue to ignore this tax.  The federal exemption has been set at over $10 million dollars.  That means that so long as your estate value is under that figure, you have nothing to worry about from estate taxes.  Or to be accurate, your heirs have nothing to worry about, because by that time, you won’t care!  But wait before you tune out!

The State of Washington has its own version of the estate tax.  For years, it just piggybacked on the federal tax, and was not a separate concern.  But when the federal rates and exemptions started gyrating, the State took the entirely reasonable step of making the tax exemption fixed and not subject to change.  However, it did so at a time when the exemption of $2 million it allowed seemed generous.  It has not been changed and is not modified by the new federal law. The exemption has grown slightly over the years due to inflation indexing, but is still around $2.1 million.  In other words, if your estate is over $2.1 million at your death, then it likely will be subject to a Washington State estate tax.  The starting rate is 10% and rapidly scales upward.  So, if there’s a total of $2.6 million in your estate, the first $2.1 million is exempt, and the non-exempt portion ($500,000) will cost your estate a tax of $50,000 (10% x $500,000). Of course, the actual calculation of estate taxes is far more complicated than that, but it’s the general idea. In this example, Uncle Sam gets $0.  But, the State of Washington pockets $50k at your heirs’ expense. Without some planning, you would have unintentionally cur the State coffers in for a share of your hard-earned estate.

Your estate planning attorney still has some “tools” in his/her tool-kit to avoid the tax.  Some of these are quite simple to prepare and implement.  But if you fail to act, your estate will have to pay.  Before you get too coy thinking you’re not in the taxable range, remember your life insurance, retirement plan, home equity and virtually all your other assets will be included in calculating your estate.  So, if you’ve got some equity in your home or business, and some life insurance for your family, you’re at risk.  Take time to have your lawyer look things over to see if you need protection. Now, in the case of larger estates – say over $4 million, more sophisticated planning may be necessary.  So, if you’ve built a business or other wealth, or just have a lot of insurance or equity in your home and don’t want to share a piece of it with the State Treasury, get some planning done.

Another tax that comes into play is income tax. It is true that generally, the receipt of an inheritance is not subject to income tax.  However, to the extent you have qualified funds – that is accounts, such as IRA’s or 401k’s – that have never been income taxed, they will be income taxed when the money comes out.  Let’s say you work for a certain large airplane manufacturing company and have stashed away $100,000 in your employer’s retirement plan.  When you retire and start drawing that money out, you will be income taxed as you withdraw it.  That’s what everyone expects.  You didn’t pay income tax on it originally, so you pay later, when you take it out.  Should you die with money still in the retirement plan, your designated beneficiaries or your estate will get saddled with the income tax.  Income taxes are hard to avoid – or plan around – however, the impact of those taxes can be dramatically lessened through effective planning. Be sure to bring your information on all of your retirement plans when you meet with your lawyer. Income tax rates on estates and trusts are the highest the law allows – far higher than personal rates – so be sure to address this.

The final tax I’m asked about is the “gift” tax.  Everyone seems to know they can give away something like “$13,000” without being taxed. The number is now (2018) $15,000, but that figure is really meaningless in most cases. Here’s why.  The receipt of a gift is generally not taxable.  If you give $15,000 or if you give $50,000 to your daughter, she does not pay income tax or gift tax on that.  Neither do you. Here’s the difference: In the case of a $15,000 gift, you don’t have to tell IRS about it. But, if you give more than $15,000 to one recipient in a year, you must file a federal gift tax return.  Still, you don’t pay tax on it. Instead, it just reduces the total, lifetime exemption you have from gift/estate taxes.  Since that figure is now over $10,000,000, the fact it gets reduced by $50,000 to $9,950,000, probably won’t affect you.  If you’ve got a bigger estate than that, we really need to talk!  Since the state of Washington does not (yet) have a gift tax, you don’t have to report to the state either, regardless of the size of the gift (except if you’re thinking about Medicaid –which is a very different matter).

Please keep in mind that Congress and the state legislature are always tinkering with taxes.  They have a peculiar love for taxing the dead, since they don’t vote (except in Chicago).  So, by the time you’re reading this post, it may already be obsolete. Your specific situation will need to be reviewed with your estate planning lawyer so decisions you make reflect the legal/tax reality as it then exists.