Many people assume that estate planning is for high-net-worth individuals who want to plan around tax issues and other complex needs.

But when you start accumulating assets or having children, you should start thinking about a plan to control what happens to your assets. And if something happens to you when you have minor children, you will want to ensure who would be caring for them.

If you don't set up an estate plan, the assets will be distributed upon your death according to the rules of intestacy, which are the rules governed by the state in which you live.

Another consequence is that your heirs can end up going through probate, a court-administered process that is best avoided if possible.

 

Probate is the legal process for heirs to obtain authority to handle a deceased person’s assets. A judge helps to determine timing of distributions, when payments to any creditors need to be made, etc. This administrative court process would cost your estate money and time with possible delays.

 

Setting up an estate plan – the right type of estate plan – can help avoid probate. A trust-based plan helps avoid probate and maintains privacy, which is why it's a popular estate-planning strategy. Whereas with a will-based plan, your estate will go through probate, although you still control who will receive your assets.

The other key difference is that the trust-based plan tends to be for more complex estate plans. For example, if you want to build continuing trusts for your children, you get different layers within a trust-based plan.

Whichever plan you choose, it should be customized to your circumstances -- where you are in your life, what beneficiaries you have, if you have children, your net worth, etc. A professional estate planner will work with you to base the plan on your goals and wishes.

 

Think about it as a five-year plan. What do you want to happen to your assets if something happens to you five years from now? It's easier to envision a plan for the next five years rather than for 20 years.

Once you've set up your plan, it's revocable and amendable while you're living and fully capacitated. Take time every few years to see if it needs to be updated to align with your current situation. Getting married or divorced, having children, and other life transitions can change how you allocate assets. Keep the five-year window in mind and you can update the plan when it's necessary.

 

A comprehensive estate plan includes four core documents: a trust, a will, a power of attorney, and a health care directive. If you have a trust-based plan, you also have a will that functions on the side of the trust (typically referred to as a pour-over will). This is to prevent any assets from falling out of your trust.

The other two documents are a financial power of attorney and a health care directive. Financial power of attorney allows you to name a trusted individual to make decisions on your behalf for financial matters if you're incapacitated during your lifetime. If something happens where you can no longer make decisions, this individual can make a bank transaction, sell a piece of property, and act on your behalf for any financial matter.

The health care directive is similar to the financial power of attorney, but you name an individual to make decisions on your behalf for health care purposes. The health care directive is the document whereby you can name someone to make medical-related decisions when you are no longer able to.

These documents name individuals to act on your behalf:

• For the trust, a trustee (doesn’t need to be a lawyer or accountant)
• For the will, an executor
• For the power of attorney, typically referred to as an attorney-in-fact
  or an agent
• For the health care directive, also usually referred to as an agent

There are potentially different considerations if you're naming a trustee of a revocable trust or an irrevocable trust. The executor and the attorney-in-fact designations are typically the person you name as your trustee. Where there may be a difference is the healthcare directive because you are delegating someone to make healthcare decisions, which may require a different level of trust or expertise.

 

A revocable trust means you can revoke it at any time. You can amend it whenever you want or you can decide the trust no longer exists. This is the type of trust that's used when you're setting up an estate plan with a trust-based plan.

An irrevocable trust is another type of estate planning tool for more complex planning. Irrevocable trusts are usually used to help minimize estate and gift taxes or for other more advanced matters. In this case, you can establish a trust for somebody else.

A prime example is when a parent might want to establish a trust for their children when the parent is still alive. They take a certain type of asset and put it into this trust so that the asset is no longer in the parent’s estate for estate tax purposes. The asset is now owned by an irrevocable trust, but since it's irrevocable, the trust can’t be changed. The trade-off is that the asset is no longer within the parent’s control.

While there are various types of irrevocable trusts, conceptually, they are used for mitigating estate taxes and maximizing your lifetime exemption amount.

Again, the key difference is that you can change a revocable trust and it's under your control. Once you make a decision to establish an irrevocable trust, you typically cannot make any changes to it.

 

One issue that many clients misunderstand when they're setting up an estate plan is that after they've signed the documents, they think they're done.

However, if you have a trust-based plan, the final and most important element is putting assets into the trust.

This is referred to as trust funding, where you're changing the title of the assets you own in your own name into the name of the trust. Depending on the type of asset, there are different ways to do so.

For instance, if you bought your house before you had a trust, you own it in your individual name. To put it into the trust, you have to draft a new deed whereby you're going to transfer the house, or your interest in the house, from yourself to yourself as trustee of your trust.

This administrative step ensures that your trust can hold title to your home. Other accounts, such as bank accounts or brokerage accounts, require you to go to the financial institution and notify them that you have established a revocable trust and want to change the title on your assets or accounts into the name of your trust. Most often, those financial institutions will provide a document that you need to fill out with the help of your financial advisor or attorney.

Funding your trust is the last step. It's important in order to avoid probate, which can only happen if you put your assets into your trust. If you create a trust and you don't have any assets in it, it's not going to fulfill what you’ve intended it to do.

Whichever type of trust you choose, it’s important to speak with a professional to guide you through the process of establishing your estate plan.

 

The keywords are unified credit. It's a dual-purpose exemption that will exempt from estate tax $12.92 million per person and $25.84 million for a married couple in 2023 (up from $12.06 million in 2022).

The gift tax component of these amounts is making gifts during your lifetime to anyone you choose. In 2023, you can use part of your $12.92 million per person exemption to make lifetime gifts.

So for example, if you are single and you gift $2 million while you're alive, as long as your estate is less than $10.92 million at your death, your heirs won’t pay any estate tax.

 

The exemption is scheduled to be reduced by more than 50% in 2026 to $6 million per person and $12 million per couple. (Note this could change pending future Congressional control, the White House, budget issues, etc.)

But in 2019, the IRS created the No Claw-Back Rule that says if you make lifetime gifts up to $12.92 million prior to 2026, the higher exclusion amount will be effective if you die after 2025.

However, if you don't use the full exemption (e.g., you only use $7 million), then after 2026, you'll have $0. If you use $5 million, after 2026, you'll have $1 million of exception left. (It’s key to discuss tax implications with your tax advisor.)

 

 

In 2023, the annual gifting exemption is $17,000 per recipient (up from $16,000) without you having to file a gift tax return. Above $17,000 per recipient, you do have to file a return. In practice, if you’re above the $17,000 annual exemption, you can dip into the lifetime exemption and end up paying no gift tax.

And for example, two parents or two grandparents can give $34,000 combined to each grandchild every year and not have to file a tax return. So if there are 10 grandchildren, that’s a total of $340,000 yearly removed from a taxable estate.

 

1. You can pay college tuition for anyone, not just family members, and it can be over $17,000 as long as payment is made directly to the college. You don't have to file a gift tax return because it's not viewed as a taxable gift. However, if you pay the student, it's going to be considered a gift even if the student in turn pays the college.

2. Charitable donations are not taxable gifts and are tax-deductible on your tax return, which reduces your estate tax.

3. Payment for medical expenses for anyone (again, not just family members) is not viewed as a gift if you make the payment directly to the providing medical institution.

 

529s can be owned by parents, grandparents, or anyone who wants to save for a child’s education. The plans are powerful tools for making gifts very tax-efficiently. You can front-load a 529 plan by using your annual $17,000 for the next five years, but accelerate it into the first year so that you put $85,000 into a 529. It grows tax-deferred and the withdrawal is not taxable if spent on the qualifying education.

 

This is where regular income tax and capital gains tax meet estate planning, estate tax, and gift tax.

People typically think capital gains tax is levied at 15% or 20%. But there is actually a zero rate of capital gains tax for up to $40,000 dollars in taxable income. If there is a capital gain and no other income, the zero capital gains tax band allows someone to recognize capital income – long-term capital gains up to $40,000 – and not pay any tax.

This is the interplay of the gift tax and capital gains tax. The gift tax exemption gives you mobility to move assets around to your family and friends. If there are a lot of gains, there could be strategies that enable you to gift the appreciated asset to someone in a lower tax bracket (0%, 15%, 20%), and you let them take the gain and report it on their tax return.

The quid pro quo is that you no longer have the asset and the person to whom you gifted it now has the asset and the profit, but these strategies assume that's your objective.

 

If you are holding an asset of a very low basis and you want to gift it during your lifetime, you can use one of the structures previous discussed.

Sometimes it might make sense to hold the asset until your death because the asset and the basis get stepped-up to the fair market value. Your beneficiaries can then sell it with no capital gains tax.

 

• A charitable remainder trust is a vehicle whereby you transfer assets to the trust. The trust (being a tax-exempt entity) then sells the assets, and you are able to access the income from the assets in the trust over the rest of your lifetime.
  
  The charitable component is that what's left inside the charitable trust goes to your nominated charity after your death. In terms of crossover between managing capital gains, income tax liability, and estate tax liability, when you transfer assets to the trust, not only do you get an income tax deduction for a portion of the assets transferred, but those transferred assets are within your taxable estate. Therefore, you don't have to report them for estate tax purposes even though you're able (and required) to access the income from the trust during the remainder of your life.
  
  What investors with concentrated stock positions can do is to transfer the stock to the trust. Based on a $1 million example, you can reinvest the entire $1 million dollars in a diversified portfolio in the trust, versus reinvesting the post-tax amount that might be $650,000 on the sale of stock worth $1 million. You can then access the income over the remaining years of your life and not pay any tax inside the trust.

• Charitable donations give you an upfront tax deduction. There are no gift taxes and whatever you give to the charity is outside your estate. A donor-advised fund receives assets outside of your taxable estate and provides a tax deduction. More complex vehicles such as charitable remainder trusts are where the income tax and the estate tax areas cross over.

An above the line deduction is an amount you can claim on your taxes that reduces how much tax you’ll owe. You can claim above the line deductions whether or not you choose to itemize your deductions.

Some examples of above the line deductions are educator expenses, student loan interest deduction, contributions to a health savings account, and amounts paid for tuition and fees.

You can claim above the line deductions by completing Schedule 1 and attaching it to your federal income tax return.

Source: Forbes

Your adjusted gross income (AGI) is your taxable income minus certain deductions. It’s a significant number because the IRS uses your AGI to calculate if you qualify for other tax credits or deductions.

Also, the IRS may ask you to provide last year’s AGI to file your tax return electronically.

Source: Forbes

Below the line deductions are amounts you can claim to reduce your overall taxes. Generally, there are two types of below the line deductions, including itemized deductions and the standard deduction. However many people do not typically refer to the standard deduction as a below the line deduction. You can choose the deduction that lowers your tax bill the most.

Source: Forbes

A capital gain occurs when you sell a capital asset, such as real estate, stocks, or bonds, for more than you paid for it. The amount of taxes you pay depends on how long you hold your capital asset.

If you hold your capital asset for less than one year, your gains are taxed at ordinary income tax rates up to 37% for 2022. If you hold your capital asset longer than a year, your gains are taxed at capital gain tax rates, which are lower. For 2022, the top capital gain tax rate is 20%. 

Source: Forbes

You may incur a capital loss when you sell an asset for less than you paid for it. For example, if you purchase stock for $2,000 in 2018 and sell it for $1,500 in 2021, your capital loss is $500.

When your total capital losses exceed your capital gains in a year, you can claim a total loss up to $3,000 to reduce your taxable income. The IRS allows you to claim any unused losses in the following tax years.

Source: Forbes

The child and dependent care credit is a tax credit available to families who pay for the care of a loved one while working, or looking for work.

The amount of the credit is a percentage of how much you paid for care up to a maximum amount. For 2022, you can claim expenses up to $4,000 for one qualifying person and up to $8,000 for two or more people.

A qualifying person must meet one of the following requirements:

• Your dependent under the age of 13
• Your spouse or dependent who is unable to care for themselves and lives with you more than half of the year

Source: Forbes

The child tax credit provides a financial benefit to families with qualifying children. For the 2021 tax year, the IRS allows you to claim up to $3,600 per child under 6 ($3,000 per child ages 6 to 17). The credit lowers the amount you owe in taxes and is fully refundable, which means you can expect a tax refund even if you do not owe taxes.

Your child must meet the following qualifications to claim the credit:

• You must claim your child as a dependent on your tax return and they’re related to you
• Your child must be 17 or younger and a U.S. citizen, national or resident alien
• Your child must have a valid Social Security number and live with you for at least half of the year
• You must provide at least half of their financial support

Source: Forbes

The cost basis is the original amount paid for an asset. For example, if you buy stock at $1,000 on Jan. 1, 2021, the original cost of $1,000 is your cost basis.

Source: Forbes

Generally, the IRS taxes cryptocurrency similar to capital gains. Therefore, how much you’ll pay in taxes on your crypto depends on how long you hold the cryptocurrency before you sell or use it. If you hold it for more than one year, any gains are taxed at the capital gain rate, up to 20% for 2022. Otherwise, if you hold it for one year or less, your gains are taxed at ordinary income tax rates up to 37% for 2022.

Source: Forbes

A dependent is someone who relies on the taxpayer for financial support. For tax purposes, the IRS allows you to claim a dependent, which may entitle you to tax breaks.

Source: Forbes

You must pay federal income taxes when you receive income throughout the year. Typically, if you’re an employee, your employer will withhold federal income taxes and pay taxes on your behalf. However, if you own a business, you must make estimated tax payments throughout the year.

Here are the due dates for the 2022 estimated tax payments:

2022 Estimated Tax Payment Due Dates

	For the period	Due Date
First Quarter	Jan. 1 to March 31	April 15, 2022
Second Quarter	April 1 to May 31	June 15, 2022
Third Quarter	June 1  to Aug 31	Sept. 15, 2022
Fourth Quarter	Sept. 1 to Dec. 31	Jan. 17, 2023*

Source: Forbes

The earned income tax credit (EITC) is designed to provide financial assistance to taxpayers who earn a low to moderate-income (defined up to $57,414 for 2021). The EITC is a refundable tax credit, which means it can reduce the amount of taxes you owe and generate a refund.

The EITC is based on a percentage of income that you’ve earned during the year, including wages, tip income, and self-employment income. However, unemployment income, alimony, child support, or interest aren’t considered earned income.

For 2021’s EITC, you can claim up to $1,502 if you don’t have children and up to $6,728 with three or more qualifying children.

Source: Forbes

Your filing status is an IRS classification based generally on your marital status. It is used for your filing requirements, standard deduction, ability to claim certain tax breaks and the amount of your tax. There are five filing statuses:

• Single
• Head of Household
• Married filing separately
• Married filing jointly
• Qualifying Widower

Source: Forbes

Interest deduction causes a reduction in taxable income. If a taxpayer or business pays interest, in certain cases the interest may be deducted from income subject to tax. Some examples of interest payments that can be deducted are interest payments for a home mortgage or home equity loan, margin account interest, and student loan interest.

Source: Investopedia

An investment interest expense is any amount of interest that is paid on loan proceeds used to purchase investments or securities. Investment interest expenses include margin interest used to leverage securities in a brokerage account and interest on a loan used to buy property held for investment. An investment interest expense is deductible in certain circumstances.

Itemized deductions are expenses you can claim on your federal income tax return to lower your taxes. Some examples are medical and dental costs, charitable donations, state income taxes and casualty losses. When choosing whether to itemize your deductions, or go with the standard deduction, use whichever is the higher amount.

Source: Forbes

Long-term capital gains are derived from assets that are held for more than one year before they are disposed of. Long-term capital gains are taxed according to graduated thresholds for taxable income at 0%, 15%, or 20%. The tax rate on most taxpayers who report long-term capital gains is 15% or lower.

Source: Investopedia

Margin interest is the interest that is due on loans made between you and your broker concerning your portfolio's assets. For instance, if you short sell a stock, you must first borrow it on margin and then sell it to a buyer. Or, if you purchase on margin, you will be offered the ability to leverage your money to purchase more shares than the cash you outlay.

Source: Investopedia

Nontaxable income is any income you receive on which you don’t have to pay taxes. Some examples of nontaxable income are child support payments, gifts, and cash rebates.

Source: Forbes

Ordinary, or non-qualified, dividends are a share of a company's profits passed on to the shareholders periodically. The dividends are taxed as ordinary income.

Source: Investopedia

A personal exemption was a dollar amount you could deduct from your taxable income, which would reduce your taxable income. However, from 2018 through 2025, the personal exemption doesn’t apply due to tax law changes by the Tax Cuts and Jobs Act (TCJA).

Before the TCJA, the 2017 personal exemption amount was $4,050, which taxpayers could claim for themselves, dependents and their spouses.

Source: Forbes

A qualified dividend is a dividend that must meet special requirements put in place by the IRS, and falls under capital gains tax rates of 20%, 15%, or 0%, depending on the tax bracket. These rates are lower than the income tax rates on unqualified or ordinary dividends, which are taxed at standard federal income tax rates. Because of this discrepancy in rate, the difference between ordinary vs. qualified dividends can be substantial when it comes time to pay taxes.

Self-employment income is money or property received for services you provide. Typically, a self-employed person is a sole proprietor, freelancer, or independent contractor.

Source: Forbes

A sole proprietor is someone who owns a business by themselves. They report their share of income and expenses on Form 1040, Schedule C. 

Source: Forbes

A short-term gain is a profit realized from the sale of personal or investment property that has been held for one year or less. The amount of the short-term gain is the difference between the basis of the capital asset–or the purchase price–and the sale price received for selling it. Short-term gains are taxed at the taxpayer's top marginal tax rate or regular income tax bracket, which can range from 10% to as high as 37%.

Source: Investopedia

A standard deduction is a flat amount that the IRS allows you to reduce your taxes based on your filing status. The IRS allows you to choose between deducting your itemized deductions or the applicable standard deduction. Choose the deduction method which lowers your tax bill the most.

2021 Standard Deduction

Filing Status	Amount
Single and Married Filing Separately	$12,550
Married Filing Joint and Qualifying Widow(er)	$25,100
Head of Household	$18,800

 

2022 Standard Deduction

Filing Status	Amount
Single and Married Filing Separately	$12,950
Married Filing Joint and Qualifying Widow(er)	$25,900
Head of Household	$19,400

 

Source: Forbes

A tax deduction is an amount that reduces the amount of your income that can be taxed, lowering your tax bill. Examples of tax deductions are standard deductions, itemized deductions, or above the line deductions.

Source: Forbes

The money you earn on investments (e.g., bonds, mutual funds, and interest-bearing accounts) for which you’re required to pay taxes. In most cases, your tax rate on earned interest income is the same rate as the rest of your income.

Taxable interest is interest on bonds, mutual funds, CDs, and demand deposits of $10 or more. Taxable interest is taxed just like ordinary income.

Source: Investopedia