Tax-Efficient Wealth Transfer to Heirs

Employing tax avoidance principles in wealth transfer is a smart approach to safeguarding your legacy and beneficiaries from burdensome taxation. Still, it requires careful planning and oversight to ensure techniques don’t cross the line to tax evasion.

Assessing tax options can determine the best way to conduct business or personal transactions and inheritance to reduce or eliminate tax liability. Tax avoidance differs from tax evasion, which reduces tax liability through concealment or deceit. Tax evasion is a crime, but tax avoidance can lower your tax bill by structuring transactions to save the most money.

Minimizing Your Heirs’ Tax Burden

Inherited assets often come with tax burdens, and planning ahead can simplify some of the processes and lower taxes for your heirs. Depending on the state of the deceased’s estate, inheritance taxes will differ. As laws and regulations change regarding inheritable assets, your estate planning attorney can conduct a routine review of your plan to ensure transferring wealth is tax-efficient.

Gifting Your Money And Assets

The most direct way to minimize inheritance tax is to start gifting your heirs money each year while you’re still alive. Taking advantage of the gift tax exclusion of $17,000 per year per person is a quick way to transfer non-taxable cash or assets to heirs. A married couple can gift $34,000 yearly to each child or other inheritor without tax consequences to the gifter or the recipient.

Life Insurance

A solid insurance plan can also set up future inheritors without tax consequences. Choosing between whole life and term life insurance will determine how long the policy will last. A term or whole life insurance policy generally provides the beneficiary a death benefit not subject to income taxes unless they receive payouts in installments.

Irrevocable Life Insurance Trusts

An irrevocable life insurance trust (ILIT) can control whole or term life insurance policies while the owner is alive. Transferring your policy to the trust or using the trust for purchase means you own your insurance policy as the trust grantor. You can determine who administers assets, designate beneficiaries, and the terms of receiving benefits. Your estate planning attorney helps you set up the trust and properly fund it.

An ILIT removes the life insurance policy from your gross estate, which minimizes or eliminates estate tax liabilities on assets not qualified as marital or charitable deductions. The policy provides immediate liquidity to the decedent’s estate and beneficiaries upon the insured’s death.

Death Benefit Annuities

An annuity with a death benefit pays a lump sum to a beneficiary. There are also joint-and-survivor annuities that provide a guaranteed income stream to the beneficiary for life. While annuities are subject to tax, they can be structured to minimize the tax burden to the beneficiary.

Retirement Accounts Converted to Roth Accounts

Heirs will pay tax on any inherited retirement benefits if they are in a 401(k) or Individual Retirement Account (IRA). However, taxes on a Roth 401(k) or Roth IRA are already settled upon conversion, so there is no additional tax on distributions. While this is great for inheritors, when the owner converts a standard 401(k) or IRA to Roth, there will be regular income tax consequences for the conversion to occur.

Real Estate

Real estate is one of the most significant non-liquid assets to pass on to heirs. Capital gains tax will apply to real estate, and the recent IRS Revenue Ruling 2023-02 removes the step up in basis even if the real estate is in an irrevocable grantor trust.

However, this new ruling doesn’t apply if the irrevocable trust is in the grantor’s gross estate. The rules and applications are complex and will require the review of an estate planning attorney to decipher.

If the property is not in an irrevocable trust, there are three other options to pursue:

  1. Sell it – If you plan on downsizing or putting your home’s equity to use elsewhere, selling the home to an heir might be a good option. It removes the property from your taxable estate, establishing a new cost basis. The property’s future sale has a cost basis tied to the home’s value on the date of transfer, lowering capital gains tax. Do not, however, sell the property below fair market value, or the difference may be subject to gift tax.
  2. Gift it – While a generous gift, providing a home to an heir during your lifetime might have negative tax consequences. This gift will count toward your lifetime gift tax exemption which may not be a problem now, but in 2026, the exemption will be cut in half as adjusted for inflation. Depending on your estate’s size, it may result in up to 40 percent federal estate tax. State-level gift, estate, and inheritance taxes may also be a factor depending on where you live.
  3. Pass it Down – Depending on how many heirs you have and their ability to maintain a property, you can leave your home in your will, a living trust, or in some states, a transfer-on-death deed. Again, these methods may no longer receive a step-up in cost basis and should be discussed at length with your estate planning attorney before making a decision.

Stock Investment Accounts

Unlike other gifted securities, inherited stocks don’t maintain their original cost basis. Upon inheriting a stock, the inheritor receives a step-up in cost basis determined by the stock’s value at the date of death. If you have held dividend-producing stocks for a significant time, the cost basis may make selling financially unproductive. However, an inheritor with a step-up in cost basis can immediately sell the stock to create cash flow without tax consequences.

Capital gain tax methods are a highly-contentious topic in the ongoing debate of inheritance and taxes. Often regulations may change without Congress enacting a law, as in the case of IRS Revenue Ruling 2023-02. To ensure your strategy is in tax compliance and advantageous to inheritors, review your estate plan routinely to account for any legal changes.

Estate Planning Attorneys and Tax Planning

Your estate planning attorney can help you legally minimize tax liabilities to your heirs by gifting assets during your lifetime, establishing trusts, and leveraging exemptions. Tax-advantaged accounts, capital gains tax planning, and other tax-efficient investments like life insurance can minimize taxes to your heirs.

Further, you can use family and charitable trusts or philanthropic foundations to receive tax benefits. There are many creative ways that your estate planning attorney can legally help to minimize taxes to your heirs. Estate planning guidance is key in creating wealth transfer management and tax strategies. Your attorney can provide personalized advice based on current tax laws and regulations and work with your tax advisor to create the best outcome for your heirs.

Contact our Ruston, LA office by calling us at (318) 255-1760 today and schedule an appointment to discuss how we can help you with your planning.