How do I protect heirs from the inheritance tax?

California residents must be particularly cognizant of certain rules that are integral to a well-crafted estate plan. Part of that is knowing about the tax implications and certain exemptions that are available for those whose estates go beyond a set amount. The current estate-tax - also referred to as the inheritance tax or the "death" tax - is $5.49 million for an individual and just below $11 million for a couple. Receiving an amount beneath these figures protects the recipient from the inheritance tax. Even with that, those who are formulating an estate plan should determine if they should use the exempt amount for the heirs or if a trust is preferable.

California does not have a state inheritance tax, but there are other issues that must be kept in mind. A time-tested manner to pass assets to relatives and other heirs is to have a credit-shelter trust. Alternatively known as a bypass trust, this is a protective device against federal estate taxes with a subtraction of gifts made to the spouse while the testator was alive. There is also a relatively new option known as portability. This lets people transfer wealth to a surviving spouse without using a trust. There are limitations with this strategy.

As recently as two decades ago, the limit for exemption was $600,000 with an inheritance tax rate of 55 percent. Credit-shelter trusts were preferable to avoid these taxes. With the increase in the amount that could be exempted, other choices emerged. Portability allowed people to steer clear of credit-shelter trusts when passing wealth on to their spouses. Trusts are not viewed as necessary with this amount of assets protected by the new laws. Portability has its limits as a spouse will not have the ability to use the exemption achieved with it to have a tax-free trust for grandchildren and it does not shield from capital gains taxes for appreciating assets. Also, portability is not a protective device if the surviving spouse who benefited from it remarries and has stepchildren. With these issues, portability could end up costing heirs more in taxes and aggravation.

Since the new presidential administration has taken office and there is talk of eliminating the inheritance tax altogether, these factors must be weighted when formulating strategies to keep as many assets as possible when crafting an estate plan. Speaking to an attorney who specializes in estate planning and probate can help to organize the best possible plan depending on the circumstances.

Source: Barron's, "How to Protect Your Estate-Tax Exemption," Matt Miller, March 25, 2017

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