Your estate plan should take into account the impact state and federal taxes, including gift and estate as well as inheritance taxes, will have on your estate. Not only do you need to know what taxes will be incurred, but you should also consider who will be responsible for paying them. The Coral Gables estate planning attorneys at Stivers Law explain how a tax apportionment clause can help you decide who pays taxes due on your estate.
Estate and Inheritance Taxes
Every estate is subject to federal gift and estate taxes at the rate of 40 percent. Currently (as of 2022), the lifetime exemption allows you to transfer up to $12.06 million in assets before the tax is levied. This includes both qualifying lifetime gifts and assets transferred at the time of death. Some states also impose a separate estate tax and/or an inheritance tax. Estate taxes are paid by the estate while an inheritance tax is paid by the beneficiaries. Collectively, these taxes can dramatically diminish the value of the assets passed down to loved ones without careful planning. When taxes cannot be avoided, you may also wish to decide who will be responsible for paying the tax bill.
How Can a Tax Apportionment Clause Help?
In simple terms, a tax apportionment clause specifies which beneficiary, or beneficiaries, will be responsible for paying taxes due to local, state, or federal governments. You can include an apportionment clause in either a Last Will and Testament or a trust agreement. Moreover, the language used in an apportionment clause can be tailored to structure your wishes regarding how the tax burden is allocated in various ways.
A common reason to include an apportionment clause is to ensure that the ultimate value of the inheritance you leave to beneficiaries is as intended. If all taxes are paid out of your probate estate assets, it may significantly diminish the value of the assets eventually passed down to beneficiaries while the value of assets passed outside of probate will remain the same. That means that assets gifted in your Will, for example, may lose value while assets gifted through a trust will not. Another related concern is to make sure that inheritance taxes are paid. Although inheritance taxes are the responsibility of the beneficiary, failing to pay them can result in litigation. Moreover, the beneficiary’s relationship to the decedent often determines if an inheritance tax is due and/or the rate of the tax. Once again, seemingly equal gifts can end up with dramatically different values after taxes are imposed. Finally, in the absence of an apportionment clause, state/federal law determines who pays taxes and how they are paid. Typically, this means they are paid out of your residuary probate estate assets. If sufficient liquid assets are not designated for the payment of those taxes, assets intended to be passed down to loved ones may need to be sold.
How Does an Apportionment Clause Work?
Within applicable legal constraints, you can craft a tax apportionment clause in any manner you wish. For example, if you want to ensure that all taxes are paid using cash assets from your probate estate, you will include language directing your Executor to do just that. In that case, taxable assets that pass outside of probate (such as life insurance, retirement accounts, and Payable on Death accounts) would not be responsible for contributing to the tax bill. If you do that, you need to ensure that your probate estate has sufficient liquid assets to pay the taxes. Failing to do so could force the sale of assets.
Alternatively, you might make it clear that taxes are to be allocated equally among all beneficiaries but paid by your estate. While this strategy sounds fair, it can also create problems if it is not clear how the taxes are to be paid. Imagine that you own a home and a life insurance policy both valued at $5 million. You leave the house to your spouse and the life insurance to your adult child. Assuming state and/or federal taxes are levied, how will your spouse pay his/her share if no additional assets are available?
Finally, you could place the tax burden directly on beneficiaries to pay inheritance taxes if they live in a state that imposes them; however, be aware that the tax could impact the value of the gift because the status of the beneficiary may impact whether that tax is imposed and/or at what rate.
Contact Coral Gables Estate Planning Attorneys
For more information, please join us for an upcoming FREE webinar. If you have additional questions or concerns about estate planning, contact the experienced Coral Gables estate planning attorneys at Stivers Law by calling (305) 456-3255 to schedule an appointment.
Justin serves as a member of the American Academy of Estate Planning Attorneys (AAEPA), a national organization comprised of legal professionals concentrating on estate planning. As a member of the Academy, he receives ongoing, comprehensive training on modern estate planning techniques.
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