Lower Your Heirs’ Tax Burden While Legally Avoiding Taxes

Applying principles of tax avoidance to wealth transfer is an intelligent way to protect your legacy and heirs from excessive taxation. Still, it requires careful planning and oversight to ensure techniques don’t cross the line to tax evasion.

What is the benefit of assessing your tax options? Determining the best way to conduct business or personal transactions and inheritance may help you 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. 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. Laws and regulations regarding transferable assets can change. A qualified 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 annually while you’re still alive. Take advantage of the current gift tax exclusion of $17,000 per year per person (as of 2023). This is a quick way to transfer non-taxable cash or assets to heirs. A married couple can gift $34,000 yearly to an inheritor without either the gifter or the recipient facing tax consequences.

Life Insurance

A solid life 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. That death benefit is 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 it 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. An estate planning attorney can help you set up the trust and properly fund it.

An ILIT removes the life insurance policy from your gross estate. This 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. Annuities are subject to tax; however, it is possible to structure them 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).

If they inherit a Roth 401(k) or Roth IRA, they will not have to pay taxes on them. They also will avoid any additional tax on distributions.

While this is a plus for the inheritors, it may not be for the account owner. The account owner may face regular income tax consequences when converting a standard 401(k) or IRA to Roth.

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. (This is the case 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 Your Property. Perhaps you are planning to downsize or put your home’s equity to use elsewhere. In this case, it may be advantageous to sell the home to an heir. 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. This can lower capital gains tax. Do not, however, sell the property below fair market value, or the difference may be subject to gift tax.

1. Gift Your Property. 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.
   
   That may not be a problem now; however, in 2026, the exemption will reduce by 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.

1. Pass Your Property Down. You can leave your home in your will, a living trust, or in some states, a transfer-on-death deed. Consider how many heirs you have and their ability to maintain a property.
   
   Again, these methods may no longer receive a step-up in cost basis. Be sure to discuss this at length with an experienced 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. (The stock’s value at the date of death determines the step-up in cost basis.)

If you have held dividend-producing stocks for a significant amount of time, the cost basis may make selling financially unproductive. However, an inheritor with a step-up in cost basis can immediately sell the stock. This creates 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. 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

A knowledgeable estate planning attorney can help you legally minimize tax liabilities to your heirs. This is possible 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 estate planners can help minimize taxes to your heirs. Estate planning guidance is key in creating wealth transfer management and tax strategies.

Seek out an estate planning attorney near you to get personalized advice based on current tax laws and regulations. They can work with your tax advisor to create the best outcome for your heirs.