How to Avoid Inheritance Tax

Four Methods:Calculating Estate TaxesMoving To Avoid State TaxesTransferring Your Estate to Your SpouseAvoiding Inheritance Tax by Reducing Your Estate

When someone dies, the money and property left to beneficiaries is subject to an inheritance tax. Yet, with some planning, anyone can learn how to avoid inheritance tax, or at least minimize its' impact.

Method 1
Calculating Estate Taxes

  1. Image titled Write a Grant Proposal Step 8
    Determine what is taxable. Estate taxes and inheritance taxes are very similar and both seek to minimize the transfer of wealth after death. If you understand how to calculate these taxes, you will also be able to understand how to avoid them. Taxable property includes cash, securities, real estate, insurance, trusts, annuities, and business interests.[1] A more in depth description of taxable items is included in the Internal Revenue Service's (IRS) Form 706, which is the Estate Tax Return.[2] Look at Form 706 Instructions as well for help understanding what is considered taxable.[3]
  2. Image titled Write a Grant Proposal Step 18
    Identify exclusions. Some items are not considered taxable for the purposes of calculating your gross estate. Generally, you will not be taxed for items owned solely by your spouse or other individuals. Life estates given to you in which title passed upon your death will not be included either.[4] Also, you will not include charitable conservation easements, social security benefits, and workers' compensation death benefits.[5]
  3. Image titled File Taxes for a Deceased Person Step 3
    Calculate your gross estate. The gross estate, which will be calculated as of the date of death, includes everything you own or have certain interests in that is taxable. Do not include any exclusionary property in this calculation.
    • When you calculate the value of these things, you will use the fair market value (FMV), not what you paid for it or what its' value was when you acquired it. The FMV is the price at which something would sell between a willing buyer and willing seller if neither were under compulsion and both had a good understanding of the relevant facts.[6]
    • For example, let's assume that when you die you have $2 million in cash, $4 million in real estate, and $3 million in annuities. You also had a life estate in a home that was passed to your spouse at your death as well as workers' compensation death benefits that went to your child in the amount of $750,000. In this scenario, your gross estate would equal $9 million.
  4. Image titled File an Extension for Taxes Step 5
    Subtract deductions. You are able to reduce your tax liability by subtracting allowable deductions from your gross estate. When you do this, the remaining amount is considered your Taxable Estate. In general you will be able to deduct the marital deduction, charitable deductions, mortgages and debts, administration expenses of the estate, and losses during estate administration.[7]
    • For example, let's assume that when you die you are able to take deductions in the amount of $2 million based on qualifying mortgages and the marital deduction.
    • Based on the example so far, your Taxable Estate (Gross Estate - Deductions) equals $7 million ($9 million - $2 million).
  5. Image titled Do a Monthly Budget Step 4
    Identify taxable gifts. Under federal law, lifetime gifts are reported and any gift tax you may owe is calculated annually. When you die, those gifts are added back into your estate for the purposes of calculating estate tax. This results in you possibly paying taxes on the wealth that you give away, as well as the wealth you have kept and accumulated. Taxable gifts are generally gifts made after 1976 that are not qualified gifts for educational or medical purposes, or transfers that qualify for the annual gift tax exclusion, marital deduction, or charitable deduction. The value of the gift is the FMV.[8]
    • For example, let's assume you have given taxable gifts in the amount of $3 million over your lifetime. When you add this $3 million to your Taxable Estate, you will have Cumulative Taxable Transfers equaling $10 million ($3 million + $7 million).
  6. Image titled File Taxes for a Deceased Person Step 9
    Determine if your estate is taxable. At this point you can step back and determine if you need to go any further. In 2016, the federal applicable exclusion amount is $5.45 million. A filing is only required if your Cumulative Taxable Transfers exceeds the exclusion amount. If it does not, you will not need to file an Estate Tax Return and you will not owe any federal estate taxes. If it does, you will have to file an Estate Tax Return.[9]
    • For example, if your Cumulative Taxable Transfers equal $10 million, your estate will be taxable and you will have to file an Estate Tax Return.
  7. Image titled Be Debt Free Step 3
    Identify your Tentative Estate Tax. Your Tentative Estate Tax equals your Tax on Cumulative Taxable Transfers minus your Tax on Adjusted Taxable Gifts. Your Tax on Cumulative Taxable Transfers is calculated based on the Unified Tax Rate Schedule.[10] In 2015, the top tax rate was 40%.[11] You can subtract your Tax on Adjusted Taxable Gifts because those were taxed during your lifetime through your annual gift tax.
    • For example, if your Cumulative Taxable Transfers equal $10 million, with a top tax rate of 40%, your Tax on Cumulative Taxable Transfers would be $4 million. However, you will be able to subtract your Tax on Adjusted Taxable Gifts. Since you had Adjusted Taxable Gifts equaling $3 million, the tax you have already paid on that amount in your lifetime would be subtracted from $4 million. Let's assume your Tax on Adjusted Taxable Gifts equals $1.2 million (this number may not be correct but you should use it for the sake of this example). If this was the case, your Tentative Estate Tax would be $2.8 million ($4 million - $1.2 million).
  8. Image titled File an Extension for Taxes Step 12
    Deduct credits. After you calculate your Tentative Estate Tax, you can begin subtracting various credits from that amount. The biggest credit is usually the unified credit. In 2013, the unified credit was $2,045,800.[12]
    • For example, you will be able to subtract the unified credit, which you will assume has stayed at $2,045,800, from your Tentative Estate Tax. Let's assume this is the only credit you can take.
  9. Image titled Choose the Right Divorce Lawyer Step 18
    Recognize your estate tax liability. At the end of all your calculations you will be left with your final Federal Estate Tax amount. In this example, the amount of tax owed would be $754,200 ($2.8 - $2,045,800). As you can see, this is a massive amount of money to owe. Because of this, it is important to understand different ways to avoid this sort of tax.

Method 2
Moving To Avoid State Taxes

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    Determine whether a state estate or inheritance tax applies. Several states have estate taxes or inheritance taxes, but these states are the minority. Inheritance and estate taxes are very similar taxes, as both seek to minimize the transfer of inherited wealth. However, an inheritance tax applies to transfers, while the estate tax applies to the estates themselves, regardless of who the recipient is.
    • The following states have estate taxes: Washington, Oregon, Minnesota, Illinois, Tennessee, Hawaii, New York, Maine, Vermont, Massachusetts, Rhode Island, Connecticut, New Jersey, Delaware, Maryland, and Washington, D.C.. For example, if you live in Oregon, the exemption threshold is $1 million and the tax rate is somewhere between .8% and 16% (depending on the size of your estate).
    • The following states have inheritance taxes: Nebraska, Iowa, Kentucky, Pennsylvania, New Jersey, and Maryland. For example, if you live in Iowa, transfers at death may incur a tax of somewhere between 0% and 15% depending on the amount of the transfer.[13]
  2. Image titled Get Out of Debt Step 6
    Use your estate tax calculations to determine your state liability. Use your calculations in order to identify your taxable estate. If your taxable estate exceeds the exemption threshold in the state you live in, you may want to consider moving in order to avoid the tax liability.
  3. Image titled Change Your Address Step 3
    Establish an alternative residency. If you live in a state with an inheritance tax and wish to avoid it, consider establishing residency elsewhere, in a jurisdiction without an inheritance tax. You may relocate permanently, or divide your time between your old residence and your new one. If you divide your time, however, be sure to establish a record that supports your claim of a new residency. Do things like change your vehicle registration, voter registration, and forward your mail to your new address.[14]

Method 3
Transferring Your Estate to Your Spouse

  1. Image titled Announce Your Retirement Step 1
    Understand the transfer rule. If a surviving spouse is the heir, there is no applicable federal estate tax as long as the spouse is a U.S. citizen.
    • If a surviving spouse is not a U.S. citizen, do some estate planning to leave a special trust to the spouse. However, the estate will be taxed once the surviving spouse dies.
  2. Image titled Develop Critical Thinking Skills Step 18
    Understand the implications of the standard estate tax deduction. The first $5.4 million of an estate is exempt from taxation. That means that if the value of your estate was $10.4 million, only the second $5 million is subject to taxation.
  3. Image titled Delegate Step 3
    Set up an estate plan. Estate planning is the best way to limit taxes.
    • Update the estate plan on a regular basis to reflect tax law changes, changes in assets, and family changes.
    • An estate plan has the added benefit of preventing disagreements between beneficiaries after a death.
  4. Image titled Open a Restaurant Step 12
    Transfer a portion of your estate to your spouse. Any amount that you bequeath to your spouse is exempt from taxation when you die. Furthermore, when your surviving spouse dies, the $5.4 million exemption would still apply. Use these exemptions to your advantage and set up a trust for your spouse of at least the amount of the standard exemption. This is an example of combining the rules to produce a favorable result for yourself.
    • For example, if your total estate was $10 million, then you could divide the estate into two equal trusts of $5 million each. The spousal exemption takes care of the estate taxes on one portion, and the exemption on wealth less than $5.4 million takes care of the remainder of the estate. This means that a $10 million estate could be completely exempted from estate taxation. Without taking advantage of the exemption, the estate would owe roughly $2 million in taxes.[15]

Method 4
Avoiding Inheritance Tax by Reducing Your Estate

  1. Image titled Create a Budget Step 12
    Give money to future heirs while alive. Individuals can receive up to $14,000 per year without being taxed. After you reach your annual limit, any other transfer will be taxed as a gift. While there is a limit of $5.45 million in tax free gifts per lifetime, up until that point is reached, you may give your future heirs $14,000 per year indefinitely.[16] Furthermore, you may deposit the money in a trust where it is protected and can accumulate over time.
    • If a gift of money is paying for higher education or medical expenses, there is no limit to the amount that can be given tax-free, as they are considered "qualified transfers."[17]
    • If there is concern about gifts to a child, a Crumby trust can be set up that allows the benefactors to require conditions on how and when the beneficiary receives access to the money.
    • If a gift is made to someone who is more than a generation younger, such as a grandchild, gifts may be subject to the generation-skipping transfer (GST) tax.
  2. Image titled Be Debt Free Step 4
    Consider life insurance. If the inheritance will be primarily non-cash assets such as property or a business, a policy for the amount of the estate taxes makes it possible for beneficiaries to retain assets rather than selling them to pay an inheritance tax.
  3. Image titled Buy a Stock Without a Stockbroker Step 5
    Transfer Life Insurance Policies to Irrevocable Life Insurance Trust. Another alternative (or subsequent step) is creating a life-insurance trust as the beneficiary of the policy in estate planning. As long as the trust is set up at least three years before death, the death benefits in the policy are not counted towards the value of the estate. [18]
  4. Image titled Market a Product Step 19
    Consider a grantor-retained annuity trust (GRAT). With a GRAT, income producing assets are transferred into the trust for the life of the trust, usually 5 years, at a discounted value. You receive annual payments and any appreciation is tax-free to beneficiaries of the trust.
  5. Image titled Negotiate an Offer Step 8
    Set up a Qualified Living Trust( QLT). A QLT removes your dwelling from the value of your estate and transfers it to a trust for a period of years (usually 10-15). While the trust owns your home, you may continue to live there. Once the trust expires, ownership of your home will be transferred to your heirs. If you still wish to live in your home, then work out a rental arrangement.
  6. Image titled Negotiate an Offer Step 6
    Transfer assets such as real estate to limited partnerships to limit the tax value of assets. Beneficiaries can then be given shares in the limited partnership.


  • Check with a tax adviser about specific situations regarding inheritance taxes.

Sources and Citations

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Categories: Taxes and Fees