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Few concerns eclipse the drive that many parents feel to provide financial security for their children. For individuals whose total assets exceed a certain threshold, however, developing a strategy for minimizing estate tax liability becomes an essential part of the estate planning process. If you are wondering how to avoid estate taxes and their potentially deleterious impacts on the legacy you are able to leave your children, designing a comprehensive estate plan with the assistance of an experienced Ohio attorney attuned to your concerns may put you in a position to make wise choices for the benefit of your children and the children who will someday come after them. Estate tax planning can be a complicated undertaking, but beginning the process early and evaluating your estate plan regularly to make updates as needed can help you to devise and maintain an effective estate plan that takes into account your own needs for the immediate future while also laying the groundwork for financial stability for generations to come.
“Generational wealth” is a term used to refer to property that is transmitted from one generation to another. In the most typical case, the assets are passed directly from parent to child, but there are a few special circumstances, as in the use of generation-skipping trusts, in which wealth may be transferred between non-consecutive generations.
While a few estate planners, who explicitly wish to distance themselves from biological families from whom they feel estranged, may have a directly adverse reaction to the concept, most people whose estate planning goals include provisions for leaving financial assets to younger family members have at least some interest in generational wealth. There are a couple of groups, however, for whom the idea of generational wealth is especially likely to take on a deep personal significance, for distinct reasons:
Plenty of people who would not place themselves in either category have an interest in estate tax planning, either for the benefit of non-familial parties to whom they wish to leave property or as a matter of simple of fiscal responsibility – but estate planners who feel the weight of an inherited responsibility because they have been been entrusted with a legacy of generational wealth themselves, and those who place a high value on ensuring for their children the financial security their own parents were unable to provide, are often especially positioned to make estate tax planning, aimed at building and preserving generational wealth, central to their overall estate planning designs.
An estate tax, according to the Internal Revenue Service (IRS), is a tax levied on an individual’s right to transfer property at their death. This definition indicates that an estate tax is a form of wealth transfer taxation, and like other wealth transfer taxes it treats as a “taxable event” the movement of property from one owner to another. Other taxes that follow the same basic model – taxing money when it moves – include:
By creating the structure for a “taxable event” in the transfer of property, the federal estate tax provides a mechanism that allows for tax to be collected on assets that might otherwise never be subject to a capital gains tax, because the owner had never “realized” the gains during life; unlike a capital gains tax, however, an estate tax is not assessed on an appreciation in value, but rather on the total value of the “estate” – the sum of an individual’s property left behind at death, although in practice the estate tax is subject to a number of exclusions and exemptions that often reduce the value of the taxable estate as compared to the entire estate as understood for non-tax purposes.
Within the United States, the two primary types of wealth transfer taxation that have estate planning tax implications are estate tax and inheritance tax. Of these two – known together, somewhat gruesomely, as “death taxes” – only the estate tax is assessed at the federal level. Six states, including Ohio’s neighbors Pennsylvania and Kentucky, levy an inheritance tax; twice as many levy their own estate tax, independent of IRS calculations, according to the nonprofit Tax Foundation. Ohio eliminated its estate tax in the 2010s, but the estates of deceased Ohio residents will still be subject to the federal tax if the total taxable value computed for the estate – always calculated based on the assets in the individual’s possession at the time of their death – exceeds the threshold established by the IRS for the year of their passing. Consequently a great deal of the emphasis in estate tax planning goes toward limiting the value likely to be computed for the taxable estate, while still ensuring that the individual putting the estate plan in place is able to build and preserve generational wealth to pass on to their children and subsequent generations.
Estate tax planning is the term used for any of a variety of estate planning strategies that aim to increase the total value of assets ultimately transferred to beneficiaries after an individual’s death by limiting the liability of the individual’s estate for estate tax obligations. Some of the estate planning tools most commonly used in minimizing estate taxes include:
Often more than one of these tools may be used together to develop a comprehensive estate planning design that in many cases also includes estate planning documents more directly associated with the planner’s personal expectations of long-term care needs and incapacity planning, such as durable powers of attorney or a living will. The requirements for each type of estate planning tool vary state by state, while the most appropriate selections will always depend on the individual’s situation and ultimate goals. An estate planning attorney with Rhodium Law may be able to review Ohio residents’ circumstances in order to assist with developing a robust, yet streamlined, set of estate planning tools tailored to individual needs.
Estate tax is assessed based on the taxable value of a decedent’s estate – the total of the individual’s taxable assets at the time of their death. If the individual left behind a valid Last Will and Testament (will), then the individual’s surviving spouse or the person the individual has named in the will to be the executor of the estate will usually be responsible for carrying out the necessary accounting, according to the IRS. If there is no will, then the person to whom the Ohio court with jurisdiction to probate the estate issues letters of administration according to the order of preference described in O.R.C. § 2113.06 will assume this responsibility in much the same way as would an executor appointed by will.
Both individuals choosing estate planning documents and those expecting to inherit from a loved one’s estate are understandably likely to focus on probate as the process by which a will is validated and the gifts the testator (the individual who creates a will) has left are distributed to designated beneficiaries. However, the disposition of property – whether in accordance with the wishes expressed by the decedent in a valid will, or pursuant to state intestacy laws through intestate succession – is only one step, and in many ways a late step, in a more complex process designed to ensure that all of the deceased person’s outstanding debts have been paid and any lingering claims against the estate settled, so that the individual’s final affairs can be concluded and all of the person’s accounts closed in an orderly fashion.
The claims of creditors – including state and federal governments – against an estate must be resolved first, before any assets designated to beneficiaries are considered definite. Although an executor may make preliminary distributions from the estate in accordance with the will, pursuant to O.R.C. § 2113.53, those distributions are subject to the resolution of the estate’s debts. Only once all claims have been settled and final taxes paid will the executor (of a will) or the administrator (granted letters of administration by the probate court) be able to determine what property is remaining to be disposed. A will, by definition, cannot avoid probate, because probate is the process that validates a Last Will and Testament and, once the estate’s debts are settled, disposes of any remaining property in accordance with the document’s terms.
Understanding the function (and placement) of a will within the context of the larger probate process suggests two important implications:
Individuals wondering how to avoid estate tax in order to prevent loss of the generational wealth they have worked hard to be able to pass on will want to use advanced estate planning strategies to limit the total value of their taxable estates.
Trusts are among the estate planning tools most popular with individuals considering how to avoid estate taxes. However, it is important to be judicious in selecting the appropriate type of trust. Not all trusts will avoid estate tax, even if they otherwise escape the probate process. This is because the “gross estate” calculation used by the IRS includes all property in the individual’s possession on the day of their passing. Revocable trusts, which allow their creator (also known as the grantor, trustor, or settlor) to retain a degree of control over the assets placed in the trust, are not exempt from estate tax even if they are set up to become irrevocable and enter the control of a new trustee (or the sole management of an existing co-trustee) upon the grantor’s death and therefore pass to beneficiaries outside of probate: The grantor’s death, which triggers the transfer of control over the trust, is the event which interrupts their ownership of property, while estate tax is computed based on the ownership thus interrupted.
Many individuals aiming to enhance their creation of generational wealth choose to include strategic gifting as part of their overall estate planning strategy. While large gifts made during an individual’s lifetime can be subject to the federal gift tax, there is a substantial exemption that can make a significant difference in long-term estate tax liability because the exemption is calculated both annually (meaning the amount resets each year) and per donee (meaning the exemption is applied separately to each individual recipient).
The IRS regularly updates the annual exclusion amounts to reflect contemporary economic conditions, so it can be a good idea to review the exclusion threshold with similar frequency. Overall, however, gifting strategically can enable an individual to transfer wealth to the next generation – or to the next few generations – while avoiding estate tax, by creating a “staggered” structure in which multiple gifts are given over a period of years. Depending on the circumstances, some estate planners may find an additional advantage to this strategy in that not only is it helpful in minimizing estate tax liability by gradually reducing the taxable value of the estate, but also it presents an opportunity to provide loved ones with financial resources they are able to enjoy and begin using in the development of their own wealth within the planner’s own lifetime – meaning that the person who has worked diligently to ensure a comprehensive plan for securing their family members’ financial futures can have the satisfaction of seeing the earliest stages of their efforts begin to bear fruit.
Many, if not most, individuals preparing an estate plan with the transfer of assets to the next generation in mind will have in place a life insurance policy. Such policies are often contracted with the goal of ensuring the financial security of specific beneficiaries, or to make sure that liquid assets are available in the immediate aftermath of the policy holder’s death (life insurance policy payouts typically have a much shorter “turnaround” time than the probate process for closing out an estate). Life insurance policies can in fact be highly effective in achieving both of these goals, and the fact that in most cases the beneficiaries designated on a life insurance policy are not required to pay taxes on the payouts they receive can make them attractive tools for transferring strictly financial resources to specific individuals efficiently.
Even beyond these potential advantages, life insurance policies can be a more flexible estate planning tool than many people realize. Life insurance proceeds can be used directly to cover the costs of estate taxes and other debts of the estate, but they can also be placed in a trust – exemplifying the truism that many estate planning tools can yield greater benefits when used in combination. One factor to consider is that, to be truly effective in achieving its long-range goals, a life insurance trust will need to be irrevocable – outside the grantor’s ability to change during their lifetime – thereby ensuring that the value of the policy contained therein (in most cases a form of “permanent” life insurance, such as whole life or universal life) is excluded from the federal estate tax calculation. An estate planning attorney may be in a position to help you determine whether an irrevocable life insurance trust (ILIT) is an appropriate option for your estate planning goals.
While an estate tax is paid out of the estate itself, and assessed on the value of the property in an individual’s position immediately prior to their death, an inheritance tax is slightly different in that it is assessed on the amount transferred to each beneficiary separately. In other words, inheritance tax – like estate tax – defines the transfer of property upon an individual’s death as a “taxable event,” but whereas estate tax levies a single tax on the value of the decedent’s entire estate before any assets are transferred from it, an inheritance tax is levied separately on each individual transfer as it is made.
Unlike estate tax, inheritance tax does not exist at the federal level in the United States. Ohio is not one of the six states that assess their own inheritance tax, meaning that in many cases Ohioans can focus their wealth transfer tax planning on estate and gift taxes – but not always. A number of the states that do impose an inheritance tax include a provision requiring the tax to be assessed on any transfer of any property located in the state when such transfer is precipitated by the death of the property’s owner, irrespective of whether that owner is domiciled in the state. At the same time, these states frequently calculate the tax rate on inheritance based not on the total value of the assets involved, but on the degree of kinship between the property owner and the beneficiary. Because some beneficiaries may qualify for an exemption from the inheritance tax altogether, whereas others may be charged a higher rate, affluent Ohioans who wish to include property held outside the state in their bequests to loved ones may wish to consult with an estate planning attorney who can advise them regarding which of their potential beneficiaries may incur the least liability for inheritance tax, as these considerations could have an impact on how an individual ultimately chooses to dispose of their property as they design their estate plans.
If you have inherited significant generational wealth, or if you have worked hard to create generational wealth to pass on to your children and the children who come after them, then you likely wish to preserve that legacy to the greatest extent possible. Minimizing estate tax liability through a combination of advanced estate planning tools can help you maximize the gifts you are able to leave for your children and grandchildren and enhance their legacy as well as your own. As you contemplate how to avoid estate taxes and ensure that the resources you have cultivated over the course of your life pass on to the next generation undiminished, consider working with an experienced estate planning attorney in your area who can appreciate your long-range estate planning goals.
The team here at Rhodium Law understands the deep significance that building and preserving generational wealth can hold for individuals who have inherited a firm financial footing themselves as well as for those who have worked their way to a position of affluence from modest beginnings. We listen attentively to each client’s concerns and take pride in understanding our clients’ estate tax planning goals from the inside out, in order to develop comprehensive estate planning strategies that not only conform with state and federal laws for the validation of estate planning documents and the handling of probate and other matters related to estate administration, but also respond directly to each client’s personal preferences and priorities. Schedule your free consultation by calling our Cleveland office today at (216) 699-8145 to begin your estate planning journey with our experienced staff.
