Estate planning is a vital way to financially prepare for the future, and the structuring of an estate plan can minimize the tax burden on an estate and its heirs. However, it is crucial to recognize that estate planning may not allow you to avoid these taxes entirely.
1. Estate taxes
In the United States, estates over a certain threshold – $13.61 million for individuals in 2024 – must pay federal estate taxes. Some states also impose their own estate taxes, with varying thresholds and rates. While many people use trusts to reduce this tax burden, only certain kinds of trusts effectively shield property from estate taxes.
2. Inheritance taxes
Depending on where they live, some people may need to pay taxes on the inheritance they receive. While estate taxes come from the estate itself before the assets pass to a person’s heirs, beneficiaries pay inheritance taxes.
3. Capital gains taxes
Capital gains taxes may apply to the sale of an asset that has grown in value. Any growth in value that occurs after the owner’s death will be subject to capital gains taxes when the heirs sell that property. Careful planning can reduce the amount of these taxes, but it may not eliminate them entirely.
4. Income taxes
Beneficiaries must also consider income taxes on any earnings generated by the inherited assets or from parts of the estate that produce income. Estate planning can help in structuring how and when beneficiaries receive this income, but it cannot completely remove the obligation to pay income taxes.
For example, if a beneficiary inherits an IRA or 401(k), they will likely have to pay income tax on the funds they receive. Similarly, if the estate includes businesses that continue to operate and generate income, the income is subject to taxation.
While it may not eliminate the need to pay taxes, estate planning is a powerful tool for minimizing the financial burden of taxes. Understanding and preparing for these tax burdens can help you and your heirs make sound financial decisions.