The estate tax is one of the most misunderstood and feared aspects of estate planning. Its detractors call it "the death tax," as though it applies to all of us when we die. In fact, Washington state and federal estate taxes apply only to a very small fraction of estates. And even for those whose estates might be large enough to hit the threshold, there are many ways to lower the rate or avoid paying the tax altogether.
The requirement to file a federal estate tax return currently applies only to estates with total assets over $5,340,000. This represents somewhere around 0.14 percent of the population. (Washington's estate tax filing threshold kicks at $2 million. There are special provisions for estates that include farmland.) The top taxable rate for the federal estate tax is at 40 percent, but the fact is that very few estates end up paying anywhere near this rate.
Some of the most common ways to lower or avoid estate tax are through trusts. Testamentary trusts can be set up to move one's assets into trust upon one's death. An inter vivos trust, also known as a living trust, can be set up during one's lifetime. In both cases, assets held in the trust are not considered part of the estate for tax purposes. Thus, they aren't subject to federal estate tax.
One common form of living trust is the grantor attained annuity trust. Under this arrangement, the grantor moves assets into the trust and then receives annual payments from the trust. Upon the grantor's death, the trust can continue making payments to a new generation of beneficiaries, or can serve many other functions without incurring a tax penalty.
Some tax avoidance strategies and trust arrangements make sense only for the wealthiest Washington residents, but many of them can help a wide range of families. Every family can benefit from an estate plan, whether it involves a straightforward will or a complex trust.
Source: Bloomberg, "Only the Foolish Pay the 45% Estate Tax," Barry Ritholtz, Jan. 30, 2014