How to Reduce Estate Tax

The amount you can transfer tax-free to your beneficiaries after you die changes every year. In 2009, $3,500,000 could be transferred without paying anything in estate tax. In 2010, you could transfer an unlimited amount of money without paying any tax. In 2010, only the first $1,000,000 is tax-free. This amount will continue to fluctuate from year to year. Fortunately, regardless of the exemption amount, there are always ways for you to reduce the amount of money your estate loses to tax.

The most common way to save on estate tax is to take advantage of the spousal exemption. Nothing you transfer to a spouse in your estate is taxable, meaning you could transfer any amount of wealth to your spouse tax-free. This comes with a big disadvantage, however: when your spouse passes away, she will have to pay tax on her personal assets and on the assets that came from your estate. While this strategy will avoid tax temporarily, your ultimate beneficiaries -- usually, in this case, your children -- will end up having to pay all the taxes before they may receive their inheritances. A better strategy is to maximize your exemption amount.

Credit shelter trusts are trusts you make to hold onto all of your assets. When you die, your estate is automatically transferred into this type of trust if you make the necessary arrangements with an attorney. Your spouse has what is called a life estate in the trust's assets, meaning she has access to the assets and may use them in any way she wishes for the rest of her life. Your children are the beneficiaries of the trust's assets, meaning that when your spouse dies, her interest in the trust ends and your children ultimately receive all of the assets. This is preferable because you get to use the full annual federal estate tax exemption amount on the assets you transfer into the trust, and then your spouse gets to use her full exemption as well. This means you can effectively double your tax-free bequests and save your beneficiaries a lot of money.

Another option is to make gifts before you die. Every year, you are permitted to give away $12,000 in gifts of cash or property to any individual. If you are married, you and your spouse may jointly give away $24,000 to any individual. This means that if you have three children, you may effectively give away $72,000 every year tax-free. This amount does not go into your estate, which means you can bring your estate below the federal exemption threshold before you die and thus pay no taxes. For example, a couple who owns $1,200,000 in assets would ordinarily be taxed on the amount over $1,000,000 (assuming they both died in 2011). This means $200,000 will be taxed. If the couple gives away $200,000 to their children over the course of three years, the couple's assets will fall below the $1,000,000 threshold and so the couple will pay no taxes on their gifts or on their estate.

Individuals with a particularly high amount of assets will benefit from making charitable gifts. Because all gifts to nonprofit organizations may be made without any tax, you can give away a large amount of money to bring yourself below the yearly threshold. While this will reduce the amount of money your beneficiaries receive, it will also reduce the amount you pay in taxes and ensure that some of your wealth goes to support a cause you believe in.

Ultimately, reducing the amount of estate tax you pay just requires some planning and consideration. Consult an attorney for even more ways to strategically bring down your inheritance tax.

Sources:

HubPages, How to Lower Your Estate Tax

LegalZoom, Credit Shelter Trusts

Forbes, Reduce Estate Tax By Making Gifts