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For many people, it is important to leave an inheritance to their posterity. If one of your priorities is to leave a monetary legacy to your children and grandchildren, it is important to plan for how to do this. This includes planning related to taxes.
Know The Difference: Inheritance Taxes vs. Estate Taxes
While these two taxes have some similarities, it is important to realize that there are some differences. The inheritance tax and the estate tax are not the same thing. Here are the basics of each:
- Inheritance Tax: States collect these taxes. The tax is on the inheritance “ the assets and cash received by an heir. Many states have repealed this tax. The way the inheritance tax is usually applied depends on who the heirs are (direct descendants are usually taxed at a lower rate than non-relatives and non-lineal relatives), and what the assets in question are. There are deductions available for those paying inheritance taxes.
- Estate Tax: This is the tax collected by the federal government on the property left behind. Individual heirs are required to pay taxes on inheritance, but with estate taxes, it is the executor of the estate who makes sure the tax is paid. This is usually done with money from the estate. There are exemptions to consider, along with the fact that estates valued at $5 million or less are exempt from the estate tax.
Of course, your goal is likely to be to reduce the taxes that your beneficiaries have to pay after you are gone.
How to Legally Reduce Your Estate and Inheritance Tax Burdens
If you want to increase the amount of money your heirs actually enjoy, you will need to make plans. Some of the strategies for protecting heirs from taxes include the creation of certain trusts for the assets, family limited partnerships, private annuities, and charitable transfers (if you want your legacy to be a cause you believe in). There are other strategies you can use, including taking out life insurance policies to cover the cost of taxes, as well. Consulting with a knowledgeable estate attorney can help you figure out the best way to pass your legacy on intact.
Of course, the best way to avoid inheritance taxes and estate taxes is to give money gifts while you are alive. In 2011 is possible for you to give $13,000 ($26,000 per couple) without it being subject to gift tax. So, if you have two children, you can reduce your estate by $52,000 a year. Of course, that amount goes up if you have grandchildren as well. And, because the gift tax is paid by the giver, your heirs don’t have to worry about paying taxes on the money.
It is also worth noting that if you make a gift of medical expenses or education expenses, you can reduce your estate “ and the taxes paid. There is no gift tax for these gifts when you make payment directly to the medical institution or educational facility (tuition only). When you give money gifts, you have the added bonus of watching your posterity spend the money.