What Are Estate Taxes?
Estate taxes are taxes imposed on the transfer of a deceased person’s assets to their beneficiaries. They are calculated based on the total value of the estate.
Some states impose additional estate or inheritance taxes, but Michigan does not have its own estate tax, inheritance tax, or gift tax. However, federal estate taxes can significantly reduce the overall value of what beneficiaries inherit. This makes estate planning crucial for minimizing tax liabilities.
How Can Estate Taxes Affect the Probate Process?
When someone dies, their estate goes through probate if they didn’t have a living trust or other estate planning measures in place to avoid it. During probate, the estate is assessed, debts are paid, and assets are distributed to beneficiaries.
The net value arrived at through this process forms the basis for federal estate tax calculations. For large estates, one major consideration is whether federal estate taxes will be owed, as this can reduce the value of what beneficiaries receive.
Common Assets That Affect Estate Taxes in Probate
Not all assets are subject to probate, and not all are taxable. Here are some key assets which can impact both estate taxes and the probate process:
- Real Estate: If the deceased owned property solely in their name, its value is included in the estate and could contribute to estate taxes.
- Investments: Stocks, bonds, and other investments are typically included in the taxable estate.
- Life Insurance: While life insurance proceeds are generally not part of the probate process, they can be included in the taxable estate if the deceased owned the policy.
- Retirement Accounts: Accounts like 401(k)s or IRAs may be subject to taxes, depending on how they’re structured.
Federal Estate Tax Considerations During Probate
The federal estate tax only applies to estates that exceed the exemption amount, so many smaller estates won’t owe these taxes. As of 2024, the federal estate tax exemption is $13.61 million.
Estates valued below this threshold are not subject to federal estate tax. However, for high-net-worth individuals, it’s critical to plan ahead, as taxes on estates that exceed this threshold can be high.
How Is the Taxable Estate Value Calculated?
The taxable estate is calculated by subtracting allowable deductions from the gross estate value. These deductions, many of which are identified and quantified during probate, can include funeral expenses, debts, and certain bequests to charities or a surviving spouse.
Additionally, certain deductions can help lower the estate’s taxable value. For example, assets left to a surviving spouse are not taxed, thanks to the marital deduction. Charitable contributions made from the estate are also deductible, as are certain debts and administrative costs related to probate.
Strategies to Minimize Estate Taxes During Probate
Several strategies can be used to minimize estate taxes during probate, allowing you to protect more of your estate for beneficiaries. Here are some of the most effective:
1. Marital Deduction
One of the simplest ways to minimize estate taxes is by leaving assets to a surviving spouse. Under U.S. federal tax law, the marital deduction allows for an unlimited transfer of assets between spouses without triggering estate taxes.
This means that if a spouse inherits the entire estate, no federal estate tax will be due at that time, regardless of the estate’s size. However, the estate could still be subject to taxes when the second spouse dies, so further planning is necessary to mitigate future tax burdens.
2. Gifting Assets During Your Lifetime
Another strategy to reduce estate taxes is through lifetime gifting. The IRS allows individuals to gift a certain amount of money or assets to others each year without those gifts being subject to federal gift taxes.
For 2024, this annual gift tax exclusion is $18,000 per recipient. By making use of this exclusion, individuals can reduce the overall value of their taxable estate. Over time, gifting can significantly reduce the estate’s size, potentially keeping it below the federal estate tax exemption threshold.
3. Irrevocable Life Insurance Trust
An irrevocable life insurance trust is a powerful tool for keeping life insurance proceeds out of the taxable estate. Normally, life insurance payouts are included in the estate’s value if the deceased owned the policy.
However, by transferring ownership of the policy to an ILIT, the proceeds are excluded from the taxable estate, provided the trust was created more than three years before the policyholder’s death. This ensures that beneficiaries can receive the life insurance proceeds tax-free, and it helps reduce the overall estate value for tax purposes.
FAQs about Probate and Estate Taxes in Michigan
Who is responsible for paying estate taxes?
The executor of the estate is responsible for filing the estate tax return and ensuring any owed taxes are paid from the estate’s assets before distribution to beneficiaries.
What is the difference between estate taxes and inheritance taxes?
The estate itself pays estate taxes before assets are distributed to beneficiaries, while inheritance taxes are paid by the beneficiaries on the assets they receive. Michigan does not have an inheritance tax, but some states do. It’s important to understand whether any state inheritance taxes apply if you’re receiving assets from an estate in another state.
How long do I have to file an estate tax return?
The estate tax return (IRS Form 706) must be filed within 9 months of the decedent’s date of death. However, a 6-month extension can be requested if needed.
How can an estate planning attorney help with probate and estate taxes?
An estate planning attorney can help by designing a customized plan that minimizes estate taxes and avoids the lengthy probate process where possible. They can assist with setting up trusts, managing gifting strategies, ensuring compliance with tax laws, and filing necessary estate tax returns. Working with an attorney ensures that your estate is protected and that your assets are passed on to your heirs in the most tax-efficient way.
Legacy Counsel Can Help You Manage Probate and Related Estate Tax
While probate and estate taxes are distinct processes, they are closely intertwined. Whether through gifting, trusts, or charitable giving, there are numerous ways to reduce the taxable estate and preserve more wealth for heirs.
Working with an experienced estate planning attorney can ensure that the right strategies are implemented, helping individuals protect their assets and reduce the impact of estate taxes on their loved ones.
Based in St. Joseph, Legacy Counsel PLC is a boutique estate planning law firm serving Southwest MI, including Berrien County, Cass County, Van Buren County, and more.
Call 269-386-5782.
