Most of my articles focus on how Christmas tree growers and forest landowners can save income taxes. Income taxes usually offer the best opportunity for tax savings because they are often the largest tax paid by most individuals and business owners.
However, Christmas tree growers and forest landowners are also subject to other taxes, such as property taxes and payroll taxes. One of these “other taxes” is the estate tax.
Although only a small percent of Americans should currently worry about the estate tax due to it only being assessed against individuals with multi-million dollar estates, all Christmas tree growers and forest landowners should be familiar with some estate tax basics.
What is the Estate Tax?
The estate tax is a tax on an individual’s “taxable estate” at death. The tax is paid by the decedent’s estate, not the individual inheriting the estate’s assets. Currently, the federal government, twelve states (CT, HI, IL, ME, MD, MA, MN, NY, OR, RI, VT, WA), and Washington DC have an estate tax. Since state estate taxes vary and do not apply to everyone, this article will focus on federal estate taxes.
An individual’s taxable estate consists of the fair market value of all assets owned, including forestland, farmland, and business interests (such as in a Christmas tree farm), plus taxable lifetime gifts, and minus allowable expenses, such as mortgages, other debts, and administrative expenses.
Once the federal taxable estate is computed, the applicable tax rate is applied, which ranges from 18-40%. Many taxable estates pay close to a 40% rate because the rate increases quickly with the size of the estate.
The good news is you are not subject to the estate tax unless your taxable estate is greater than the exemption amount. For 2021, the federal exemption amount is $11.7 million on an individual basis. Married couples may combine their exemption amounts, meaning a married couple will not be subject to the estate tax in 2021 unless their combined estates are greater than $23.4 million.
Example #1
Patrick and Penelope Pine are a married couple with a taxable estate of $12 million. They will pay no estate tax because their taxable estate is less than the combined exemption of $23.4 million.
Example #2
Same facts as Example #1 except that Patrick and Penelope have a taxable estate of $25 million. They will pay an estate tax of $585,800 on their taxable estate of $1.6 million ($25 million taxable estate – $23.4 million exemption amount).
This exemption amount has increased substantially over the last 25 years:
In 1997, the estate tax exemption was only $600,000. President Biden has suggested that part of his tax plan will include decreasing the estate tax exemption, which means more individuals would be subject to the estate tax at death.
How to Avoid the Estate Tax
Estate Less Than the Exemption Amount
The way most individuals avoid the estate tax is by having a taxable estate that is under the exemption amount. For 2021, with the exemption at $11.7 million ($23.4 million for a married couple), most Christmas tree farmers and forest landowners will not be subject to the estate tax because their estate will be under the exemption amount. However, the exemption amount is likely to decrease in the future, meaning more Christmas tree growers and forest landowners will be subject to the estate tax.
What if your estate is over the exemption amount now or will likely be in the coming years? There are a few other general ways to avoid the estate tax:
Give Away Your Assets
Gifts to Charity
Any gifts made during your lifetime to charity are not included in your taxable estate at death. Also, current gifts to charity are eligible for an income tax deduction. If you are currently above the exemption amount, giving to charity provides a double benefit: reduced or eliminated estate taxes and lower income taxes.
Example #3
Same facts as Example #2, except that Patrick and Penelope give $2 million to their favorite charity in 2021 before their death. They owe no estate tax because their taxable estate is $23 million ($25 million taxable estate – $2 million charitable gift), which is less than the $23.4 exemption amount. Patrick and Penelope will also be eligible to deduct the $2 million contribution on their income tax return, subject to possible limitations.
Gifts to Individuals
Any non-taxable gifts made during an individual’s lifetime are not included in their taxable estate. For 2021, an individual can give up to $15,000 yearly to an individual without triggering a taxable gift. This exclusion is on an individual basis, like the estate tax exemption, so a married couple can give up to $30,000 yearly to an individual.
Example #4
Same facts as Example #2, except that Patrick and Penelope each give $15,000 to their two children, two children’s spouses, and six grandchildren ($15,000 x 2 x 10 = $300,000). Their taxable estate is now $24.7 million ($25 million taxable estate – $300,000 gifts), which means they will not pay estate tax on the gifts totalling $300,000.
Gifting to family is a great way to lessen your taxable estate. One of the most famous examples of this strategy is Sam Walton. When he started his business that would become Walmart in 1953, he gave a 20% stake in the business to each of his three children, 20% to his wife, and kept 20% for himself. This strategy saved Sam Walton and his family hundreds of millions, if not billions of dollars, in estate taxes. Sam is quoted as giving this timeless tax advice: “the best way to reduce paying estate taxes is to give your assets away before they appreciate.”
Spend Your Assets
Another way to decrease your taxable estate is to simply spend more. While this is easy to do if most of your assets are cash, stocks, or bonds, this will likely be difficult for many Christmas tree growers and forest landowners because their main assets (land and trees) are illiquid. Further, if you have extra money to spend, you will likely spend it on assets that may appreciate, which may not have a measurable impact on decreasing your taxable estate.
Create Trusts
This strategy is similar to gifting. Certain types of trusts can be created for the benefit of your heirs that will decrease or eliminate your estate tax. Assets put in qualifying trusts will not be included in your taxable estate since they were gifted to the trust during your lifetime. If you are looking to create trusts to decrease your taxable estate, you should consult knowledgeable CPAs and attorneys. The tax reduction strategies can get very complex and professional guidance is necessary.
What Should I Do If I’m Not Subject to the Estate Tax?
If you are not currently subject to the estate tax and are unlikely to be at your death, you should still be aware of two important things: estate planning and step-up basis.
Estate Planning
Although it includes “estate” in the name, estate planning is for everyone, not just those with a taxable estate. At a minimum, all Christmas tree growers and forest landowners should have a basic estate plan in place. The specifics will vary based on your individual situation, but you should likely have a combination of the following: a will, a living trust, a living will, and a health care power of attorney. You should meet with both your accountant and attorney to discuss, as well as have the proper documents drafted. Christmas tree farming and forest landownership are unique, so it is best to find professionals who are familiar with their intricacies.
Step-Up Basis
Generally, inherited property receives a “stepped-up” basis which exempts any appreciation in the hands of the decedent from income taxes. Choosing to leave property at your death to your heirs, rather than a sale or gift during your lifetime, often results in lower taxes.
I highly recommend discussing the impact of step-up basis with your estate planning professionals, especially if you are planning on leaving an entity interest, such as closely-held stock or an LLC interest, to your heirs. The situations can get complex and special considerations need to be made to ensure proper tax treatment.
Conclusion
Every Christmas tree grower and forest landowner should be familiar with estate tax basics even though only a small percentage of Americans are currently subject to the estate tax. Everyone should have an estate plan, regardless of their wealth, to facilitate an efficient transfer of assets upon death and minimize any potential estate taxes. Estate taxes will likely increase in future years, meaning proper planning is crucial!
Have further questions about how the estate tax may impact you? Contact Andrew!
