Trusts Law

How Do the Rich Avoid Taxes With Trusts?

Key Takeaways:

  • Most Americans will not have to worry about passing on an estate tax bill to their heirs when they die.
  • You can move assets to an irrevocable trust to lower the size of your taxable estate.
  • The grantor retained annuity trust, intentionally defective grantor trust, charitable remainder trust, and dynasty trust are trusts commonly used to minimize estate taxes.

You’ve heard that taxes can take a big bite from your estate. So big that your loved ones could lose up to 40% of their inheritance to these taxes. But most of us won’t have to worry about the federal estate tax because we aren’t rich enough. But if you fall into the group that would have to pay the estate tax, you can use trusts to lower your tax bill.

This article explains how you can use trusts to minimize your estate taxes. Trusts are complex, and laws vary by state. Talk to a trust planning attorney in your state for estate planning help. They can ensure your trust meets your goals. They can also help you create a trust to minimize your tax liability.

What Is the Estate Tax?

The federal estate tax is a “transfer tax” assessed by the federal government. It taxes estates whose value exceeds a certain amount when passing the estate on to beneficiaries. This value is the estate tax exemption amount, which changes yearly. The federal estate tax exemption is $12,920,000 in 2023 for an individual. It’s doubled for a married couple.

Your estate only pays tax on the amount over the exemption. So, for example, if your estate is worth $5M when you die, it doesn’t have an estate tax bill to worry about. But if its value is $20M, it’s liable for estate taxes on the approximately $7M that exceeds the exemption. The tax rate depends on how much it exceeds the exemption. It starts at 18% and maxes out at 40%.

Some states also have an estate tax. You may need additional planning if you live in one of those states.

What Is the Gift Tax?

Another transfer tax you should be aware of is the federal gift tax. One strategy to lower the size of your taxable estate is to give your estate away while you’re alive. Congress created the gift tax to capture the tax revenue lost when people use this strategy.

You only pay a gift tax on the amount of your gift that exceeds the annual gift tax exclusion. In 2023, the exclusion is $17,000 yearly. It’s calculated for each person who receives a gift from you. So you can gift up to the exclusion amount annually per person without paying the tax. For example, in 2023, you can give your three kids up to $17,000 each without paying the gift tax.

Types of Trusts To Minimize Taxes

A trust can be an excellent tool for tax planning. Following are some of the types of trusts high-net-worth people use in their tax avoidance strategy:

  • Irrevocable trust: An irrevocable trust is a trust that you can’t terminate or change. When you transfer assets to an irrevocable trust, you give up control of them. That effectively removes them from your estate.
  • Grantor retained annuity trust (GRAT): A GRAT is a type of irrevocable trust. You can transfer assets to the trust while getting an annuity payment. If the assets in the trust appreciate enough, you can pass that excess value to your heirs with little or no tax. GRATs are a popular wealth transfer strategy with ultra-wealthy Americans.
  • Intentionally defective grantor trust (IDGT): An IDGT is another type of irrevocable trust. You transfer assets to the trust tax-free, but you must pay income tax on the revenue generated by the trust’s assets. The assets in the trust can grow and be passed to your beneficiaries tax-free.
  • Charitable remainder trust (CRT): While you’re alive, you can make money from the appreciating assets you put in the CRT. When you die, the assets go to a charity. That allows you to avoid capital gains taxes and lower your estate taxes. Your estate also gets a charitable tax deduction.
  • Dynasty trust: A dynasty trust is a trust designed to last for several generations. It allows you to pass wealth from generation to generation without transfer taxes.

Contact an Estate Planning Attorney for Help

Wealthy people can use trusts to pass wealth to their family members with little or no tax. But using trusts to lower your tax bill can involve complex estate planning. An experienced estate planning attorney with experience in using trusts can give you legal advice. They can also help you structure your estate plan to achieve your goals.

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