Estate planning involves deciding how to plan for the management of your money, property, and well-being before your death and how to distribute your money and property after your death. A comprehensive estate plan should consider the impact that taxes can have on your estate and ensure that your estate is distributed in a tax-efficient manner. There are several different types of taxes that can impact you and your estate plan, including individual income tax, estate income tax, trust income tax, gift tax, estate tax, generation-skipping transfer tax, and state inheritance tax.
Federal Individual Income Tax
The federal individual income tax is a graduated tax (the tax rate adjusts based on the amount being taxed) that individuals pay on their personal income. If you currently own income producing assets such as rental property, stocks, or a business, the income they generate is subject to income tax, and the tax liability can be significant. Alternatively, charitable entities are typically subject to lower tax rates and no capital gains. We can discuss whether transferring accounts and property to a trust or charitable organization would benefit you, where the value of income-producing accounts and property and their future income can be removed from your taxable estate. On the other hand, owning appreciating accounts and property until death will allow them to receive a basis adjustment to their fair market value as of the date of your death, which can eliminate or significantly reduce capital gains taxes if your beneficiaries sell property or liquidate accounts. When considering these planning strategies, it is important to weigh the income and estate tax consequences.
Federal Trust Income Tax
Trusts are legal entities that can hold and manage accounts on behalf of one or more people (beneficiaries). There are several kinds of trusts and their tax treatment varies. As a separate entity, some trusts are subject to their own federal income tax. Trusts reach the highest marginal income tax rate much faster than individuals and most trusts are subject to income tax on any income their accounts and property generate and retain. Also, depending on the trust structure, tax liabilities can impact the value of the trust. Money paid by the trust for income tax liabilities, means there is less money available to the beneficiaries. If the trust distributes money or property to the beneficiaries, the income tax associated with the money or property is then paid by the beneficiaries at their individual income tax rates.