Articles Posted in Estate Tax

In December 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act, with the intention of facilitating the creation and use of retirement accounts, including individual retirement accounts (IRAs) and 401(k) plans. Whether intentional or not, the bill has eliminated a popular tool used in estate planning known as the “stretch IRA,” which allowed people to convey an IRA to their heirs while minimizing tax liability. Some options may still be available, though, and our Los Angeles tax advisors can explain them.

What Was a Stretch IRA?

A stretch IRA was a way of passing both the value of a retirement account and its tax deferrals from generation to generation. The term does not describe a type of account, but rather a strategy used to maximize the returns on a retirement account passed down through a will with a minimal tax bill. It was most commonly used with traditional IRAs, which defer income taxes on contributions until the money is distributed to the owner or other beneficiary.

Under new rules found in the SECURE Act, owners of traditional IRAs must begin taking required minimum distributions (RMDs) by a certain date. The amount of the RMD is based on the account owner’s life expectancy, using IRS tables. The remaining balance of the account is divided by the number of years left in the owner’s life expectancy.

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One aspect of estate planning involves devising strategies to minimize the amount paid in federal taxes out of one’s estate. At the end of 2017, the total exemption for the federal estate, gift, and generation-skipping transfer (GST) taxes doubled. This increase is currently set to expire after eight years, after which it will revert to pre-2018 levels. This provides taxpayers with a limited window of time to take advantage of the significantly higher exemption amounts. Our Los Angeles tax advisors can help you make use of this opportunity.

What Are the Estate, Gift, and GST Taxes?

The Internal Revenue Code (IRC) defines the estate tax in a rather circular fashion as a tax on “the transfer of the taxable estate of” a decedent. The gift tax is defined in a similar fashion as a tax “on the transfer of property by gift.” A highly-oversimplified definition of GST is a transfer to an individual, known as a “skip person,” who is at least two generations younger than the transferor, such as a grandchild and grandparent. The term “skip person” may also refer to a trust in which all beneficiaries are skip persons.

Tax Exemptions for 2020 and Beyond

The IRC allows for a “unified credit” against the estate tax, which also covers the gift and GST taxes. The tax reform law passed in 2017 amended the IRC to double the unified credit from $5 million to $10 million, with adjustments for inflation. The adjusted unified credit for 2020 is $11,580,000, or $23,160,000 for married couples. Those numbers will likely increase in 2021, and every year after that through 2025. The unified credit amount reverts to $5 million, adjusted for inflation, on January 1, 2026, unless Congress amends the IRC again.

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The estate tax applies to property transferred by a will or other probate proceedings. Congress has set extensive limitations on who is obligated to pay estate tax. The most recent tax reform bill, enacted in 2017, more than doubled the size of estates that are excluded from estate tax liability. A handful of states have enacted their own taxes on estates or inheritances, but California is not among them. Even if a person does not expect their estate to be large enough to incur an estate tax liability, understanding how the tax works is an important part of estate planning.

What Is the Estate Tax?

The Internal Revenue Code (IRC) defines the estate tax as a tax on “the transfer of the taxable estate of every decedent who is” a U.S. citizen or resident. The executor of the estate is responsible for paying the tax.

The tax is calculated as a percentage of the value of the non-exempt part of an estate. Tax rates start at eighteen percent for values of $10,000 or less. For a value of more than $1 million, the amount of tax is $345,800 plus forty percent of the amount in excess of $1 million.

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