Estate & Inheritance Tax Planning

Only a small percentage of estates are subject to federal estate taxes. However, many estates will meet the threshold to qualify for a state inheritance (or estate) tax. In many states, inheritance taxes have been phased out (Ohio being one of them) but in others like New Jersey and Pennsylvania, these taxes still exist and can add up quickly.

Without a doubt, federal and/or state inheritance taxes can be difficult for beneficiaries to manage in the absence of long term planning.The following will discuss the state and federal tax codes and the steps you can take to reduce your tax liabilities. Please contact us to learn more about these valuable estate planning strategies.

Understanding State Inheritance Taxes In PA & NJ

Estate TaxThe Ohio inheritance tax phased out January 1, 2013. In New Jersey and Pennsylvania, that is not case. It is a good idea to visit your state’s tax website to understand which asset classes are taxable and which are not.

New Jersey Inheritance Tax Website

Pennsylvania Inheritance Tax Website

Certain assets can help to reduce and or avoid state inheritance taxes when setup properly. For instance, when deciding between an annuity and a life insurance policy in Pennsylvania or New Jersey it is good to know that the annuity would count as a taxable asset, but the life insurance proceeds would not. This is provided that the life insurance is made payable to a named beneficiary.

Countable Assets For State Inheritance Taxes

Assets can include real estate, savings and investment accounts, trust assets, business interests, tangible personal property, stocks, bonds, etc. In PA, farmland can avoid this tax under certain provisions.

In many cases, an estate consisting of mostly real property (homes, rental properties, etc.) may have a difficult time generating the necessary funds to settle tax liabilities. Oftentimes families must sell property at a discount in order to create liquidity to settle an estate. On the other hand, estates with more liquidity will have to cash in certificates of deposit, annuity and brokerage accounts to cover inheritance tax debts. (Certain types of annuities may avoid inheritance taxes in New Jersey.)

Avoid State Inheritance Taxes With Life Insurance

Not all assets are considered countable when determining an estate’s value however. One asset not included in an estate’s net worth is life insurance made payable to named beneficiaries. For tax purposes, this makes life insurance more advantageous than most annuity accounts, bank certificate of deposit, brokerage accounts, real estate and other tangible property like works of art.

As long as the life policy is not paid directly to your estate, it is not counted for estate tax purposes in Pennsylvania and New Jersey. Additionally, life insurance proceeds are also income tax free to your beneficiaries. When setup properly, life policies are not subject to inheritance or income taxes in these two states.

Avoid New Jersey & Pennsylvania Inheritance Taxes

Single premium life policies can be valuable assets not only to avoid taxes, but also for growth and certainly to transfer wealth. Consider that a reasonably healthy 60 year could multiply his or her premium two fold or more with a life policy. And the death benefit would not be subject to income or inheritance taxes.

What was once a $50,000 dollar bank CD or annuity account, can now be a life policy with a $100,000 tax free death benefit to a chosen beneficiary. Additionally, certain life insurance policies can provide benefits to the insured for long term care expenses. You can learn more about the advantages of single premium life insurance here.

Federal Estate Tax Exemption Rates

Moving on from state inheritance taxes, there are also federal estate taxes to consider for high net worth individuals. The chart below details the threshold for federal estate tax amounts.

Calendar Year Federal Gift Tax Exemption Federal Estate & GST Tax Exemption Highest Federal Estate & GST Tax Rates
2006 $1,000,000 $2,000,000 46%
2007 $1,000,000 $2,000,000 45%
2008 $1,000,000 $2,000,000 45%
2009 $1,000,000 $3,500,000 45%
2010 $1,000,000 Unlimited NA
2011 $1,000,000 $5,000,000 35%
2012 $1,000,000 $5,120,000 35%
2013 $1,000,000 $5,250,000 40%
2014 $1,000,000 $5,340,000 40%

Reducing Your Federal Estate Through Gifting

In order to reduce these burdens, US residents can gift a portion of their estates away during their lifetime. The IRS allows for a $14,000 individual ($28,000 for married couples) gift each year to any number of people. Recipients can include children, a child’s spouse, grandchildren and even friends.

These gifts however are subject to the Unified Credit amounts. This simply means that once you have given away more than your federal estate tax exemption ($5,340,000 for 2014) then your gifts are subject to the 40% estate tax rate. A surviving spouse can give away any unused portion of a deceased spouse’s Unified Credit however.

Avoid Federal Estate Taxes With Life Insurance

Much like planning for state inheritance taxes,many large estates can help to offset tax liabilities using life insurance policies. Life insurance proceeds can be leveraged to account for larger federal estate tax obligations.

As long as the decedent does not own the life insurance policy and the policy is not made payable to the estate, the IRS does not count those funds toward the gross estate. Unlike the New Jersey and Pennsylvania inheritance tax where only the beneficiary designation of the life insurance policy is most important, ownership and beneficiary designation matter most when calculating federal estate taxes.

There are several techniques that will keep life insurance from being taxed by the federal government. Ownership of the policy is the key issue. When purchasing a life policy an individual can appoint his or her children as the owners. (If the policy was purchased in the past, the owner may assign the policy to a child.)

Alternatively, individuals or families with larger estates might gift the maximum $14,000 to their children each year and in turn have the child use those funds to pay for a life insurance policy. While all of these methods will reduce the size of the owner’s estate and provide a system to pay for inheritance taxes, they can be difficult to implement without proper guidance. Reassigning ownership and implementing the maximum gift allowance to purchase a life policy can trigger unwanted taxable consequences when setup incorrectly.

Using An Irrevocable Life Insurance Trust

Yet another method used to avoid direct ownership of a life insurance policy is the creation of an irrevocable life insurance trust, or ILIT. In this case, the trust is assigned a new tax identification number, rather than the owner’s social security number, and the trust owns the life insurance policy outside of the estate. An adult child might be appointed trustee of the irrevocable life insurance trust and assist in funding the policy’s premium each year.

At the passing of the insured, the proceeds can be used by the estate’s beneficiaries to help offset any tax liabilities. Although this option requires the services of an estate planning attorney, it can be more favorable due to the binding nature of a trust document.

Contact Us For Information And Assistance

In summary, federal estate and the state inheritance taxes In New Jersey and Pennsylvania will be a significant outlay for many residents. Larger estates will face sizable tax burdens from their respective state governments, the IRS – or both at settlement.

Consumers should consult a qualified estate planning attorney, an experienced accountant and a knowledgeable insurance agent to discuss the options available to them. With a proper estate plan in place, tax liabilities can be accounted for making the settlement process less difficult and less expensive for those involved.

Contact Us To Discuss Life Insurance Strategies

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