Estate and Death Tax Fundamentals and Planning Part 3 – Live Webinar Sept 30, 2021

By: Christopher Ha, Staff Attorney, Certified Financial Planner, CFP®

Purpose of Blog Post

            Purpose of blog post: let you know that we’ll be hosting Part 3 of our Estate and Death Tax Planning Fundamentals series later this month.

Goal of series: give you the foundational knowledge about estate and death taxes so you can make sure you don’t pay Uncle Sam a dollar more than necessary at death!

What We’ll Cover in Part 3

           In Part 3 we’ll cover:

  1. How to use a Irrevocable Life Insurance Trust (ILIT) to make sure your life insurance death benefits are NOT subject to a 40% estate tax at death
  2. Income Tax planning for Traditional IRAs / 401ks
  3. Income Tax planning – getting stepped up income tax basis on assets at death

Sample Life Insurance Discussion and Example

            Recall that general formula to calculate estate taxes at death is:

Add:                Gross Estate

Less:                Estate Deductions

Less:                Estate Exemptions

Equals:                        Taxable Estate

Apply the Estate Tax Rate of 40% to the Taxable Estate to figure the Estate Tax Due.

Note that certain members of Congress are lobbying to reduce the Estate Exemption and to increase the Estate Tax Rate to cause Americans to owe more in estate taxes at death.

Life insurance proceeds have mixed tax treatment:

  1. Life insurance proceeds are generally NOT subject to income taxes at death. Income taxes are the taxes you pay every April 15 on items such as wages, rental income, dividends, and interest.
  2. HOWEVER, life insurance proceeds ARE part of a Decedent’s Gross Estate for ESTATE (death) tax purposes.

Example with Mama Texas:

Mama Texas dies on January 2, 2026. Mama Texas is single and leaves everything she owns to her two kids in equal shares.

Under current law, Mama Texas’ estate tax exemption sunsets from $11 million (rounded) to $5 million (before inflation adjustment) on January 1, 2026. We’ll use $5 million as her Estate Tax Exemption for this example.

Mama Texas has the following assets:

House:                                     $3,000,000

Cash and Investments:            $2,000,000

Life insurance death benefit   $1,000,000

Mama Texas’ estate tax attributes are:

Estate Tax Exemption:            $5,000,000

Estate Tax Rate:                      40%

Assume for simplicity that Mama Texas has no estate tax deductions.

 

Questions:

Q1. What is Mama Texas’s Gross Estate?

 

Q2: What is Mama Texas’ Taxable Estate?

 

Q3: How much does Mama Texas owe in Estate Taxes at death?

 

Sample solution below:

Gross Estate = value of all assets at death.

House:                                     $3,000,000

Cash and Investments:            $2,000,000

Life insurance death benefit   $1,000,000

Gross Estate                            $6,000,000

Note, that although the life insurance death benefit is NOT subject to INCOME taxes, the life insurance death benefit IS subject to ESTATE (death) taxes because it is part of Mama Texas’s Gross Estate.

Below, we calculate Mama Texas’ Taxable Estate:

Add: Gross Estate                   $6,000,000 (see calculation above)

Less: Estate Deductions         $0

Less: Estate Exemption          ($5,000,000)

Equals: Gross Estate               $1,000,000

To calculate how much estate tax Mama Texas owes at death:

Gross Estate:                           $1,000,000 (see calculation above)

Multiply by Tax Rate:            40%

Equals:                                                $400,000

 

Result: the Executor of Mama Texas’ estate needs to write a check to IRS for $400,000 to IRS within 9 months of Mama Texas’ date of death.

The estate tax should be paid prior beneficiaries receiving their inheritance from Mama Texas’ estate. Failure to pay the estate tax exposes the beneficiaries and Mama Texas’ executor to a lawsuit by IRS.

Reason for this exercise:

  1. Show how life insurance death benefits can trigger ESTATE taxes even though they are not subject to INCOME taxes, and
  2. Lay the foundation to introduce an Irrevocable Life Insurance Trust (ILIT) which causes the life insurance policy to be completely exempt from estate taxes if managed properly. In the example above, a properly executed ILIT would have saved Mama Texas $400,000 by removing $1,000,000 from her Gross Estate.
  3. Additional info: if Congress expands the estate tax regime further (e.g., reducing the estate tax exemption or increasing the estate tax rate), then the estate tax savings from using an ILIT will increase.

I hope this has been helpful and hope to see you during Part 3 of this webinar series: Estate and Death Tax Fundamentals and Planning.

 

Link to YouTube page with recordings of Part 1 and Part 2:

https://www.youtube.com/channel/UC-ioEjIhCMuI412XSk0aKjA

 

Planned time for live webinar of Part 3:

 

Thursday, September 30, 6:30pm.

We’ll be posting Zoom invitation as we get closer to the webinar date.

Hope to see you there!

 

Items Covered in Previous Presentations:

 

  1. How to calculate estate taxes owed at death under current rules (2021)
  2. Possible estate tax traps with a sweet-heart Will estate plan
  3. How to transfer your estate tax exemption to your spouse (portability)
  4. How a Bypass Trust can shield assets from estate taxes regardless of how large the assets in the Bypass Trust grow