Ultimate Estate Tax Guide

How estate taxes work, how to minimize unnecessary taxes, and transfer your wealth to your beneficiaries.

What are Estate Taxes?

Estate taxes, sometimes referred to as Inheritance Taxes, are levied after someone has passed away. There is a federal estate tax that kicks in after $15 million dollars in assets, so most folks aren't subject to federal estate taxes. What can be surprising though is that several states have a state level estate tax that can be much lower. In fact, Oregon has the lowest estate tax threshold in the nation.

Estate Taxes in Oregon and Washington

In Oregon you can pass $1 million tax-free. This includes all life insurance, retirement accounts, real property, and personal property. Every dollar over $1 million is taxed from 10% up to 16%.

In Washington you can pass ~$3 million tax-free. Including all life insurance, retirement accounts, real property, and personal property. Every dollar over ~$3m is taxed from 10% to 35%.

Planning Opportunity #1: Married Couples

Married couples can reduce their estate tax bill by planning ahead, and incorporating estate tax planning into their overall estate plan. Traditionally, spouses say 'I want everything to go to my spouse for their benefit'. Which is fine. Spouses may transfer, tax-free, as much as they want to their legal spouse.

The problem becomes if Husband is worth $1.5 million and his wife is worth $1.5 million then their combined net worth is $3 million. If Husband gives everything to his wife outright that will pass tax free, then his wife's estate goes from $1.5 million up to $3 million. At wife's death she can only pass $1 million tax free. The remaining $2 million will be taxed.

If Husband instead created a trust that benefitted his wife, then his estate would 'give' $500k to his wife, and $1 million to a trust that is designed specifically to take care of his wife. The husband passes $500k tax free to his wife using the marital deduction. Then he passes $1 million tax free to the trust for his wife's benefit. At wife's death all that is in her estate is her original $1.5m plus husband's $500k = $2 million at her death. She'd still have to pay taxes on the $1 million her estate is above her exemption amount. However, now the $1m held in a separate trust created by her husband can pass tax free to the next beneficiaries (usually the children). Husband and Wife have effective sheltered an additional $1 million in assets that pass tax free to the intended beneficiaries. This is sometimes referred to as a bypass trust, ab trust, or credit shelter trust.

Planning Opportunity #2: Gifting

Another way to potentially reduce estate taxes is to gift property during your life time. An individual can give up to $15 million, tax free, during their lifetime. This is called the lifetime gift tax exclusion. A common misconception that people believe that can only give up to the annual exclusion amount ($19k per person, per year), otherwise they'll incur taxes. Which isn't true. You can give more than $19k per person per year without incurring gift taxes. Gift taxes are only owed if you go over $15 million during your lifetime. If you give more than $19k in a year then you will be required to file a Gift Tax Return. No tax will be owed, but you will be required to submit the return. This you functionally telling the IRS 'hey, my $15 million exemption? Please reduce that by $100,000 because I helped my child buy a house.' The IRS then keeps a tally for every gift tax return.

For folks who are less than $15 million, but more than $1 million (in Oregon) or $3 million (in Washington) then it can be beneficial to explore gifting sums of money to your intended beneficiaries during your lifetime instead of waiting until after you've passed. Warning! The type of asset matters A LOT when deciding what to gift. The best type of gift is cash because there will be no capital gains owed, but if you are gifting stocks, real property, or something else then you are trapping your basis.

An asset that is gifted to someone else traps the basis. Meaning, when the gift recipient goes to sell the asset they received as a gift then they may be paying significant capital gains tax. For example, if mom gifts her rental home to her son on her death bed (to avoid estate taxes), then her son receives the home with mom's basis. If mom purchase the home in 1980 with a husk of corn, and two dimes. Then when son goes to sell the rental home for $1.1 million, then he'd pay capital gains taxes on the difference between the value in 1980 compared to the value he sold it for.

Instead, if mom had instead given her son liquid cash assets, and kept the rental home in her estate. Then at her death the rental home's basis would increase from the 1980 value to the value it was at the date of mom's death. Meaning, when the property is sold capital gains is only paid on how much the value increased from the date of death to the date of the sale of the property. This can be a significant capital gains saving!

Folks, in their excitement to avoid estate tax sometimes accidentally incur more taxes in the form of capital gains than if they had just paid the estate tax in the first place and got the step-up-in-basis at death.

It's vital to have a really great estate planning attorney and CPA who can work together to help you asses how best to minimize unnecessary taxes.

Planning Opportunity #3: Charitable Gifts

Another option could be incorporating charitable gifts to reduce your estate tax bill. By naming charities in your will or trust, or even better on retirement accounts. You can significantly reduce or eliminate estate taxes for your other beneficiaries. In some cases it might even be beneficial to establish a charitable remainder trust, or explore setting up a Donor Advised Fund.

Warning: Estate Tax Trap! Non-Residents Who Own Real Property in Oregon or Washington

Many people fail to realize that merely owning property in Oregon or Washington subjects it to estate tax, even if you aren't a resident of Oregon or Washington. Non-residents are considered taxable based on world-wide assets.

Example: You are a resident of California, which does not have estate taxes, and you own a rental property in Oregon for $500k. Many folks assume that no Oregon estate tax return, or taxes would be due. This is not necessarily true. If you own your home in California (~$1 million) then you would owe taxes on the proportion of your estate that is made up of Oregon real property. In this scenario your estate is worth $1.5m, and $500k of that is in Oregon real property. Your estate is one-third Oregon property. Meaning, the Oregon Department of Revenue would calculate your total hypothetical tax (the first $1 million passed tax free, and the next $500k would be taxed at 10%). Your hypothetical estate tax bill is $50k, if you and all your assets were in Oregon, but because your primary home is in California then the bill would be reduced. One-third of $50k, is $16,667. Because your estate was made up of one-third Oregon real property then your estate tax bill would be $16,667. Many folks, even attorneys, make the mistake of assuming that because your Oregon property is less than $1 million then you won't be subject to estate taxes, but that isn't true.

Have a knowledgable estate planning attorney help you navigate estate taxes is vital to minimize estate taxes. A sophisticated planner might put the property in the above example into an LLC which converts the property from real property to personal property, which is not subject to estate taxes for non-residents of Washington or Oregon.