Probate Blunders #11 Forgetting About Taxes

Misjudging or even forgetting about taxes can be a costly mistake in estate planning. While many people assume that they don’t need to worry about taxes because their estate isn’t large enough to trigger the federal estate tax, other taxes should be considered. In this article, we’ll delve deeper into the dangers of forgetting about taxes and provide tips on how to avoid them.  

Failing to Understand State Inheritance Tax Laws

One of people’s biggest mistakes regarding taxes and estate planning is failing to understand the state inheritance tax laws. While the federal estate tax only applies to estates above a certain threshold, many states have their own inheritance taxes that may apply to smaller estates. These taxes can be significant and cause your beneficiaries to be hit with a large tax bill.

For example, let’s say you live in Florida, which does not have a state inheritance tax but does have a state estate tax that applies to estates valued at $5.7 million or more. If you don’t plan for this tax and leave a $6 million estate to your beneficiaries, they could be hit with a tax bill of over $300,000. This can be a significant burden, especially if your beneficiaries are not financially prepared for it.

To avoid this danger, it’s important to work with an estate planning attorney familiar with your state’s tax laws. They can help you understand how your estate will be taxed and develop a plan to minimize the tax burden on your beneficiaries. This may involve making gifts during your lifetime, setting up trusts, or other strategies to reduce the size of your taxable estate.

Failing to Consider Capital Gains Tax

Another danger of forgetting about taxes when completing end-of-life documents is failing to consider the capital gains tax. This tax applies to selling assets, such as stocks or real estate, that have appreciated in value. If you leave these assets to your beneficiaries, they will receive a step-up in basis, which means that their cost basis for tax purposes will be the asset’s fair market value at the time of your death.

However, suppose you transfer these assets to a trust. In that case, the trust may not receive a step-up in basis, which means that your beneficiaries could be subject to a significant capital gains tax if they sell the assets in the future. To avoid this danger, it is important to work with an estate planning attorney who can help you structure your trust in a way that minimizes capital gains tax and ensures that your beneficiaries receive the full benefit of the step-up in basis.

Failing to Consider the Generation-Skipping Transfer Tax

The generation-skipping transfer tax is another tax to consider when completing end-of-life documents. This tax applies when you transfer assets to a beneficiary who is more than one generation younger than you, such as a grandchild. This tax is in addition to the federal estate tax and can be as high as 40% of the value of the transferred assets.

For example, let’s say you want to leave your grandchild a $1 million estate. If you don’t plan for the generation-skipping transfer tax, your grandchild could be hit with a tax bill of $400,000. This can significantly reduce the value of the inheritance you leave to your loved ones.

To avoid this danger, working with an estate planning attorney who can help you structure your estate plan to minimize the generation-skipping transfer tax is important. This may involve setting up trusts or other strategies to transfer assets to your grandchildren in a tax-efficient manner.

Conclusion

In conclusion, forgetting taxes when completing end-of-life documents can be costly. To avoid this danger, working with an experienced estate planning attorney who can help you understand the risks and develop a plan to minimize the tax burden on your beneficiaries is important. Remember to consider state inheritance tax laws