When a person dies and bequeaths assets to his heirs, inheritance taxes may apply if the estate is valued over a certain limit. For 2012, this limit is $5,120,000. Fortunately, there are several ways to reduce or eliminate inheritance tax. Many of these solutions require some advance planning because you must transfer assets while you are still alive. To calculate the value of your estate, subtract all funeral expenses, debts of the decedent and charitable contributions. Transfers to your spouse are exempt from inheritance tax. In 2012, the unified credit entitles you to a lifetime exemption of $1,772,800 against gift and inheritance taxes.
A will instructs the probate court to distribute the estate's assets according to your wishes. This allows you to structure your inheritance to minimize the taxes your beneficiaries will owe. You can leave your beneficiaries property that is worth less than the minimum threshold for inheritance taxes or donate some of your assets to charity to reduce the taxable estate.
You can also give part of your estate away during your lifetime to reduce the inheritance tax owed after your death. Each parent can give $13,000 to each child during the 2012 year without paying gift tax. Gifts in the last three years of your life are included in the estate when calculating inheritance taxes. The beneficiaries must pay inheritance tax as if the property was never transferred.
A trust lets you provide income for your surviving spouse and children while protecting your assets from inheritance tax after your death. Loan trusts operate as an interest-free loan to the trustee. The trustee's repayments produce income during your lifetime. When you die, the outstanding loan balance is added into the estate value. You can set up a credit shelter trust, also known as an AB trust. When you die, the trust splits into two new trusts, with Trust A containing your property and Trust B containing your spouse's. Your spouse may use the property in Trust A during her lifetime and the remainder will be distributed to your designated beneficiaries after her death. Your spouse may designate her own beneficiaries to receive the remainder of Trust B.
A Qualified Terminable Interest Property trust holds assets on behalf of your spouse during her life. You must still name final beneficiaries to inherit the remainder after both you and your spouse die. Your spouse is only entitled to the income produced by the trust during her lifetime. Upon her death, the property in the trust passes on to the designated beneficiaries.
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