How Business Owners and Investors Can Legally Avoid Federal Estate Tax

Arguably the number one driving factor of small business owners throughout the United States is the promise to be able to provide and care for our families and …

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Arguably the number one driving factor of small business owners throughout the United States is the promise to be able to provide and care for our families and children. When we have left and passed, we hope to leave a financial legacy and comfortable life for those we leave behind. But the United States is home to one of the largest estate taxes in the modern world.

The estate tax, known by its opponents as the “death tax” is the federal tax imposed on your estate when you pass. Although the tax is known as an estate tax, it encompasses all of your property including: land, cars, money, stocks, bonds – and your business. In addition to the federal estate tax and state inheritance tax, your estate will pass through the probate process, taking an additional 10% for probate costs and court fees. As of December 31 each person will be allowed to transfer $5,000,000 in assets to a beneficiary. This number will be indexed for inflation and rise to $5,250,000 the following year. All amounts over this exclusion will be taxed at 40%. For those of us who invest in properties and businesses this may leave our heirs with a devastating and impossible tax bill upon our death.

Why is it important for small business owners to look in to estate planning?

In addition to the tax benefits if your heirs receive a portion of the estate they may be obligated to pay taxes on the estate – without being in possession of the liquid assets to do so. This creates an immense financial and legal burden for the heirs and beneficiaries. Estate planning can also streamline the business succession process while avoiding probate.

Below we’ll discuss options to eliminate your federal estate tax- legally.

Charitable planning: Rather than donate your fortune to the IRS, your fortune or property can go to the charity of your choice. Charitable planning is a method of asset protection in that the part transferred to the federally recognized charity can not be taxed. Your donation will not only serve as a philanthropic good, but will also support the causes you believe in and be used in a way that you wish.
 
Offshore planning: Many people are under the misconception that an offshore account or trust is an illegal and grey area of law- however this is far from the truth. Although there are those who use offshore planning to engage in illegal activities, a competent professional would never put you in danger of legal prosecution. There are many benefits to be enjoyed by creating an offshore trust or corporation, these include: increased privacy rights, multiple tax benefits and with modern technology relatively easy access. Creating offshore entities or trusts will also protect your estate from future creditors should you ever face a frivolous lawsuit. However it should be noted that offshore planning is mainly reserved for those with a large amount of liquid capital

Trust formation: Creating a trust allows your assets to completely bypass the probate process. There are many different types of trusts with different tax advantages to each. One such trust, an irrevocable living trust, receives the payout from your life insurance policy and keeps it separately from your taxable estate. Following your death your beneficiaries will receive the insurance payout tax-free, and can use it to pay any estate taxes pending against your assets. Irrevocable living trusts are ideal for those whose assets are largely made up of real estate or property.

Use of the gift tax: The gift tax applies to the transfer of property during your life, and was put in to place so that individuals could not try to redistribute their wealth during their life to avoid taxation. If you have children or loved ones you can gift them a maximum of $14,000 a year per individual (double that per couple).

LLC formation: By creating an LLC, particularly a family LLC your spouse and heirs become immediate recipients of your estate, business and property. LLCs centralize the management and authority of assets and offer both tax advantages and non-tax advantages by minimizing the property transferred upon death while providing creditor protection during your life. Gifting through a FLLC can also increase gift tax exemptions by nearly double the amount.
 
Is an estate tax the same as an inheritance tax?

No- although the two are often used interchangeably the estate tax is a federal level tax on the transfer of the estate from you to your beneficiaries. The inheritance tax is a state level tax on the portion of the estate the beneficiary received. States that currently implement an inheritance tax are: Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. What this means is that many estates are taxed twice before they reach their heir- and may be taxed again during the probate process.

So who should look in to estate planning?

Asset protection attorneys are usually hired by people who, because of their situation, have a higher chance of lawsuits. These include: small business owners, real estate investors, hedge fund managers, CPAs, attorneys, doctors etc. Anyone who has amassed a substantial amount of wealth should seek a wealth protection strategy that will maximize the value of the legacy they leave behind, while minimizing risk during their lifetime.

Things to keep in mind:
  • It is always cheaper to make lifetime gifts than to gift one lump sum at death
  • Failing to create a solid estate plan will result in an automatic amount being taken from your estate during the probate process, up to 10% of your estate’s entire value
  • Estate planning can also protect your assets from future creditors or lawsuits

Ultimately your estate can only transfer to three places: the IRS, your beneficiaries or a charity of your choice. It is essential to enact proper planning in advance of any misfortune, frivolous lawsuit or the passing of a loved one.  

 

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