As your business grows, it's likely you'll start thinking to the future—to the sale of your business and to the money you'll make from that sale. But with many business sales, owners face new tax concerns. A common one is how to pass on the money they've amassed without creating an enormous tax bill. In this article, we share some strategies you may be able to use to reduce or eliminate federal and state estate taxes.
Important disclosure: The strategies shared in this article should not be used without your accountant, attorney, and financial planner’s oversight. Be sure to speak with professionals to ensure that these strategies are effective options for your financial situation.
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What are estate taxes?
Estate taxes are taxes that can be incurred at the federal and state level upon your death. They're levied against the property, cash, stock, or other assets you transfer to your heirs.
Is everyone required to pay this tax?
It’s estimated that 99.8 percent of estates pay no estate tax. However, the estate value minimums that trigger estate tax change frequently, and those minimums are often a heated topic among lawmakers.
In 2020, individuals could leave $11.58 million in assets to their heirs before incurring this tax, while married couples could shield up to $23.16 million. This level of exemption is scheduled to decrease to $5.6 million per individual in 2025.
Decreases could continue, and in fact, future exemption levels are not guaranteed. When planning, keep in mind that it's possible that exemptions could be eliminated altogether before you pass.
Is this tax different than an inheritance tax?
Yes. Estate taxes are paid by the estate, and inheritance taxes are paid by the beneficiary of the assets that are transferred on death.
How much should I expect to pay?
As of 2020, federal estate taxes were as high as 40% for taxable amounts greater than $1 million.
Among the twelve states that had state estate taxes in 2020, the tax rates and thresholds varied. However, state thresholds are often lower than the federal threshold. The Tax Foundation offers this useful guide to the locations and rates of specific states’ estate taxes:
How can I reduce my estate taxes?
Estate planning can help you reduce your estate taxes or eliminate them altogether. Your accountant or attorney can walk you through strategies, such as the following, to lower your tax liability:
Under current federal tax law, you may gift assets to family members each year up to a defined federal limit without incurring tax debts.
In 2020 and 2021, taxpayers could gift $15,000 per recipient, or $30,000 per married couple, without incurring a gift tax. Current law does not restrict the number of people you can give gifts to each year. Because of this, you may wish to begin distributing your assets up to the current gifting limits before your death to reduce the size of your estate enough to either reduce your estate tax rate or lower the value of your estate to an amount that is less than the current tax threshold.
|When gifting, consider gifting assets that will appreciate in value.
By doing so, any future gain produced by the asset won’t be included in your taxable estate. The recipient of your gift may be required to pay a capital gains tax on the gift, but it will likely be less than the estate tax you’d pay if the asset were to remain in your estate.
If you have a large estate, you may plan to donate a portion of your assets to a charitable cause upon your death. However, you might be able to lower your estate tax rate or avoid estate taxes altogether by making yearly donations through the remaining years of your life.
There are some tax considerations to keep in mind when making charitable donations. Speak with your accountant and review IRS guidelines on charitable contribution deductions before pursuing this option to ensure you understand the short-term and long-term tax implications.
|Interested in starting a planned giving strategy? Sites like Charity Navigator and Give.org can help you find charitable organizations that suit your objectives.|
Create a family limited liability company
Many tax accountants and attorneys advise wealthy business owners to establish a family limited liability company (LLC) to remove assets from their taxable estate and reduce or eliminate their estate taxes.
If you choose to make this smart tax move, you can establish an LLC operating agreement that suits your specific goals. For some, these goals could include preventing anyone who is not a blood relative from purchasing or receiving an interest in the family LLC.
An often-overlooked benefit of family LLCs is their ability to shield your assets from creditors’ claims both during your lifetime and after your death. Speak with a tax accountant or attorney to structure your family LLC to realize this benefit and long-term tax advantages.
Explore other trust agreements
You might consider establishing trust agreements to reduce your estate tax liability and protect your personal assets. Some trust options to consider include:
- A charitable remainder trust that allows you to place cash or property into a trust that pays you and named beneficiaries a stream of income each year and ensures that the remainder of the assets are given to a charity or charities of your choosing
- A special needs trust that allows you to set aside money from your estate for a disabled beneficiary
- A qualified personal residence trust (QPRT) that allows you to remove the value of your residence from your taxable estate
- An irrevocable life insurance trust that owns and controls life insurance proceeds that are paid out upon your death
Your attorney can help you review your trust options and select one that both affords you tax advantages and helps you ensure that your end-of-life wishes are carried out.
Purchase additional life insurance
After taking other steps to reduce your estate tax liability, you may find that paying some amount of estate taxes is unavoidable. One way to lessen the burden of paying those taxes is by buying additional life insurance.
Many savvy business owners buy a life insurance policy that will be used to pay the estate taxes you’ll incur upon your death. Life insurance policies come at a cost: you will need to pay premiums. However, those premiums tend to be significantly less expensive than the taxes your estate must pay after your death.
Your business insurance agent may be able to refer you to a life insurance carrier. However, many business owners use one of these popular platforms to set up their life insurance policies: Some popular life insurance providers include:
How can I connect with a knowledgeable accountant or attorney?
Estate planning and tax planning are complex issues, especially for people with a high net worth. We can connect you with experts who can help.
Here are a few of our favorite accounting teams. Connect with them and see if one of them is a good fit for you:
You can also connect with our network of attorneys to find one who can help you set up effective tax-minimization plans. Get started here:
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