Federal estate tax applies when property such as cash, stocks, real estate and other property is transferred from a deceased person to his or heirs. However, estate tax does not apply to everyone. In fact, only about two out of every 1,000 estates in the U.S. are subject to the tax because of the high exemption amount that exists, according to the Center on Budget and Policy Priorities.
In 2015, the estate tax exemption is set at $5.43 million per person (or $10.86 million per married couple). That means if the net value of a person’s estate is worth less than that amount when he or she dies, the estate tax does not apply. The purpose of the tax is essentially to limit the tax breaks that the very wealthy get on their fortunes as the fortunes grow over time.
However, even if an estate is worth more than the exemption, it’s still possible to reduce or potentially avoid the tax with some careful estate planning tactics. This is a very important step for people who qualify because federal estate taxes are very high and they must be paid in cash, usually within nine months after the death.
There are many ways of planning to reduce or avoid estate tax, but here are the four most common approaches:
Giving tax-free gifts before death
Each year, you are allowed to give up to a certain amount of money tax-free (in 2014 and 2015 it is $14,000), thereby reducing the size of your estate. These gifts can also take the form of paying someone’s tuition, medical bills or mortgage.
Our next post will highlight the remaining three most common approaches that can be taken to reduce or eliminate estate taxes.