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In this blog post, we discuss some wealth transfer tax strategies for Ohioans to consider. Wealth transfer taxes, which in the United States typically consist of taxes on large gifts and decedents’ estates, can be among the most confusing and frustrating tax categories individuals encounter during the estate planning process. Developing tax-efficient strategies for the transfer of wealth is crucial to ensuring that the legacy you pass on to your children or other beneficiaries will not be unduly reduced by the taxes owed on your estate, as well as to limiting the taxes you yourself may be expected to pay for generous gifts made to loved ones during your lifetime.
Tax-efficient estate strategies are legal methods for reducing the taxable value of an individual’s estate, or (similarly) maximizing the amount an individual can give away without being required to pay tax on the value of the gift. Devising tax-efficient estate strategies is one of the most common reasons why people with substantial asset portfolios seek out the support of an experienced estate planning attorney. Even individuals who appreciate wealth transfer taxation’s ostensible social and economic goals may easily feel some resistance to paying a wealth transfer tax themselves. More altruistically, they may dread the thought of leaving their loved ones not simply a generous inheritance, but a substantial tax liability to go with it.
The desire to avoid steep tax penalties that reduce the total value of gifts or inherited wealth can be especially strong among those whose wealth was not, in fact, acquired initially through “transfer.” Individuals from middle-class or even disadvantaged backgrounds, who started their careers with no family wealth to speak of, and who in many cases may have faced not only long hours of hard work but also various social and economic barriers to success – some of them potentially rooted in the same societal inertias to which wealth transfer taxes, at least in concept, are designed to offer a partial corrective – are often understandably keen to avoid either paying themselves what can easily seem like a “penalty” for generosity when making a gift, or on the other hand leaving family members an inheritance sharply reduced by federal estate tax.
At the other end of the spectrum, individuals whose own wealth was primarily or partially inherited often feel a deep sense of responsibility for managing the family legacy. These individuals are often driven to develop estate plans that minimize taxes on the transfer of assets to the next generation in service to what they see as their duty of stewardship, ensuring that the legacy they inherited is not diminished, but increased, by its time in their care.
Whether you will be the first in your family to pass on a substantial financial legacy, or you want to do your part to ensure that the generational wealth you have enjoyed is passed on intact, the key to choosing tax-efficient estate strategies that meet your goals will likely lie in developing an understanding of wealth transfer tax liability. This understanding is especially important because gift taxes and estate taxes differ somewhat with respect to their tax liability thresholds as well as in the more obvious point of when these taxes are assessed.
The IRS considers any transfer of property from one individual to another to be a gift if the transferring individual either receives nothing in exchange, or receives something that is worth less than the full value of the property they have transferred. Gift tax is typically paid by the person giving the gift, so assessing the potential amount of tax to be paid may be a question worth considering for individuals who are contemplating large gifts.
Neither the type of property transferred nor the relationship between donor and donee (other than between spouses) matters for the purpose of calculating wealth transfer tax liability. The amount of money or value of property transferred, however, can make a substantial difference – as does the question of whether the gift is considered a “present interest” vs. a “future interest” according to IRS guidelines. Present, but not future, interests allow for an “exclusion,” up to which the value gifted to a single recipient in a calendar year is considered exempt from the gift tax.
An estate tax, as its name suggests, is paid out of the value of a decedent’s estate. Like gift taxes, in the United States the federal estate tax is charged only after the total value involved exceeds a certain threshold. Ohio repealed its state-level tax on decedents’ estates in 2013 and sunset its provisions for recovering taxes for late-filed estate taxes in 2022, according to the Ohio Department of Taxation. However, an Ohio resident’s estate may still be liable for the federal estate tax if its total value at the time of death exceeds the IRS threshold for the year in which the individual passes away.
Because any estate tax must be paid before any gifts left to beneficiaries in accordance with the terms set out in the Last Will and Testament can be considered definite, estate tax has the tendency to reduce the size of the inheritance these beneficiaries ultimately receive. Tax reduction estate planning strategies therefore tend to be aimed at limiting the size of the “gross” estate that will be considered in the computation of federal estate tax.
While limiting gift tax liability can be an important consideration in certain circumstances, limiting estate tax liability is likely to be a greater, or at least a more persistent, concern for a larger number of individuals preparing their estate plans. Estate tax liability, therefore, offers many opportunities to plan in advance, but like so many other concerns associated with death it is attended by a certain air of finality. This is largely because, while gift tax liability can to some extent be reduced simply by giving somewhat less, or distributing the amount given to a single recipient over multiple calendar years, estate tax liability is based on a one-time calculation that takes as its starting point the gross value of the estate at the time of the decedent’s death. Consequently a good many of the most popular tax reduction estate planning strategies are aimed primarily at reducing that initial “gross value” calculation.
Individuals who plan carefully may in some instances be able to make strategic use of the gift tax threshold to reduce the tax liability of their estates. The IRS threshold for the gift amount eligible for tax exemption is calculated per donee and the total calculation for each donee resets annually, while the total tax liability of the estate is computed from the value of the decedent’s gross estate plus lifetime taxable gifts (subject to certain adjustments). Only if the resulting figure exceeds the federal estate tax threshold for the year of the decedent’s death will the estate’s personal representative need to file an estate tax return. One strategy for reducing total liability for both gift and estate taxes, therefore, is to make incremental gifts, over time, to the same individuals named in the Last Will and Testament as beneficiaries of the estate.
Besides direct gifting, there are a variety of other tax-efficient estate strategies that individuals may use to reduce the tax liability associated with their estate and, consequently, maximize the size of the inheritance they are able to pass on to beneficiaries. The right combination of strategies can depend on a variety of factors, but typically these will include such considerations as the size of the estate, the type of assets included, and the number and needs of the intended beneficiaries. An Ohio estate planning attorney with Rhodium Law who is familiar with tax-efficient strategies for wealth transfer may be able to review your situation and help you select an appropriate suite of tax reduction estate planning tools to match your goals and priorities.
Assets placed in a specific type of trust, called an irrevocable trust, will be excluded from the decedent’s probate estate. This exclusion means that the assets contained in the trust will also be exempt from calculation as part of the gross estate (legally, the assets belong to the trust and not to the individual who creates and funds the trust). Forming a trust, naming beneficiaries to whom its wealth will be distributed, and appointing a trustee to oversee the trust and ensure that the property included will be apportioned appropriately, according to whatever terms the grantor sets out in the trust instrument (the legal document used to create the trust), can be a somewhat complicated undertaking – but it can also be a highly effective strategy for limiting wealth transfer tax liability. Keep in mind that, to limit beneficiaries’ potential liability for taxes on assets considered to be income, it may be important to consider how and over what period of time your loved ones will receive the legacy you wish to leave them.
Life insurance policies are typically transferred directly to their designated beneficiaries, free of tax. While life insurance as a vehicle for the transfer of wealth has an obvious downside in that the policyholder may end up paying a significant amount in premiums over time, a life insurance policy can still be an efficient means of ensuring that a key beneficiary receives a substantial financial gift on your passing. In many cases, the beneficiary may even be able to choose whether they receive their benefit as a lump-sum payment vs. an equivalent value spread across multiple payments over a period of time.
While a summary of some of the most popular means for reducing wealth transfer tax liability can be helpful, individuals who have questions about wealth transfer taxes often find it both illuminating and reassuring to discuss their concerns with an experienced professional who can provide answers tailored to their specific needs.
The estate planning team at Rhodium Law considers it an honor and a privilege to support clients in developing tax-efficient strategies to help them build generational wealth or pass their inheritance on to the next generation. Call (216) 699-8145 from anywhere in Ohio to request a consultation and discuss your tax reduction estate planning goals with Rhodium Law.
