Numerous changes have been written into the inheritance tax codes governing the payment of death taxes in various states. Changes in the federal estate tax code in 1976 reduced taxes at the federal level. Similar updating in many states recognized inflation and its effect on both estates and inheritances. Despite substantially increased exemptions, inheritance taxes -- those taxes imposed on what an individual receives from an estate as opposed to state taxes on the full estate -- impose an uneven burden.
In California, for example, beginning Jan. 1, 1981, inheritances by the spouse of a decedent are exempt. The exemption for a minor child increases from exemption for Class C heirs (essentially nonrelatives) only increases from $300 to $3,000. California permits adult adoptions as one way of improving the status and reducing the inheritance tax payable by Class C heirs, as noted previously in "Moneywise" regarding the book "Adopt Your Way to Inheritance and Gift Tax Savings," by Charles P. Moriarty Jr., a lawyer.
Other ways to avoid or reduce inheritance taxes include the following:
1. Moving from a high-tax state to a noor low-tax state. Retirees who move could consider the inheritance tax code of a prospective new location. It is the law of the state in which one lives at the time of death that controls the estate's taxation -- not the location of an heir. If you move, you should not continue to own real property in the former state or you might possibly be taxed in two states. Only Nevada has neither an estate nor inheritance tax.
2. Giving assets to one's children avoids an inheritance tax -- sometimes. There are two kind of gifts.
Each year a person may give up to $3,000 to as many donees as desired without paying a tax to either the federal or most state governments. These gifts are not controlled, and you could, if desired, give 2, 10, 100, or any number of $3, 000 gifts in one year with no tax liabilities. Further, if you are married, your spouse can also give as many $3,000 gifts as desired to different donees. Thus, if you and your spouse have four children, the two of you could give $6, 000 to each of the four for an estate reduction of $24,000 in one year. The next year you can give another $24,000. The $3,000 annual gifts are not subject to a time limit. A person could give $3,000 to children or others on his deathbed, and the gift would not be taxable. These annual gifts represent a practical and useful way to reduce one's estate to exemption levels or to amounts subject to minimum taxes.
Gifts larger than $3,000 must be reported to both federal and state authorities. A gift tax may be due, but the unified gift-estate tax at the federal level accounts for both within one limit. The credit now available to offset federal estate taxes effectively eliminates the tax due on a net taxable estate of one person equal to $175,625. State exemptions tend to be considerably smaller. There is one catch, however. Gifts exceeding $3,000 and reported as required will be included in the decedent's estate if death occurs within three years.
Giving an appreciating asset affords one offsetting benefit. The value of the gift is figured as of the date title is transferred. For example, a piece of real estate may be worth $50,000 on the date it is given. Five years after the date of death it may have climbed to a market value of $80,000. For unified gift and estate tax purposes, it would be included at $50,000 rather than the $ 80,000 figure.
Whenever a substantial amount is involved -- that is, the amount over exemptions -- you should consult a knowledgeable tax lawyer or CPA.