Reducing Your Taxable Estate

Most Iowa families will never owe a federal estate tax. The federal exemption is high, it is indexed for inflation, and it is portable between spouses, so a couple can shelter far more than a single person. The Iowa inheritance tax has been phased out for recent deaths. That does not mean tax planning is pointless. It means the goal has shifted from avoiding a death tax to controlling income tax, protecting a surviving spouse, and keeping the right assets in the right hands.

The federal estate tax in one paragraph

The federal estate tax applies only to estates above an exemption that Congress sets and adjusts over time. A surviving spouse can generally use any unused exemption of the first spouse to die, a rule called portability, if the executor makes the required election on a timely filed estate tax return. Because the exemption is high, the tax reaches a small share of households, mostly those with large farms, businesses or investment portfolios. The exact figure changes, so check the current number with the IRS rather than relying on an old one.

Why the income tax usually matters more

For many families the larger issue is capital gains. Property you own when you die generally receives a new basis equal to its value at death, which wipes out the gain that built up during your life. If your heirs sell soon after, they often owe little or no capital gains tax. Property you give away during your life usually keeps your old basis, so the recipient inherits your gain. A gift that looks generous can hand the recipient a tax bill you did not intend. This is the single most common mistake in do-it-yourself estate tax planning: giving away highly appreciated assets to lower the estate, and creating a worse income tax result for the family.

Gifting during life, and its limits

Federal law allows a person to give a certain amount each year to each recipient without using any lifetime exemption or filing a gift tax return. Larger gifts count against the lifetime exemption. A married couple can split gifts, doubling the annual amount to a single recipient. Gifting can reduce the size of the taxable estate and move assets to people who need them now. It also gives up control and, as noted above, may carry a lower basis. Gifts of a home or a farm raise their own questions about retained use, valuation and the risk of being treated as something other than what the paperwork says.

Charitable giving

Gifts to qualified charities are deductible for estate tax purposes and can reduce an estate that is over the exemption. A charitable remainder trust pays income to a person for life and leaves the remainder to charity, which can convert a low-yielding asset into income and a deduction. A donor-advised fund lets a person take a deduction now and decide on the recipients later. Charity is not a reason to disinherit the family, and a plan that gives everything away to avoid tax usually reflects a misunderstanding. The point is that charitable tools exist and can fit a family that already gives.

Life insurance and the estate

Life insurance proceeds are not subject to income tax, but if the deceased person owned the policy, the death benefit can be counted in the taxable estate. For a large policy on someone with a substantial estate, ownership can be moved to an irrevocable life insurance trust so the proceeds stay outside the estate. This is a specialized step with strict rules, including the three-year lookback if an existing policy is transferred, and it only makes sense when the estate is large enough to face the tax at all.

Retirement accounts and the surviving spouse

A surviving spouse who inherits a retirement account has options that other beneficiaries do not, including the ability to treat the account as their own and to continue tax-deferred growth. Other beneficiaries generally must withdraw the account within a set period and pay income tax on what they take. Naming the right beneficiary, and planning the order of withdrawals, can matter more to a family's bottom line than the estate tax ever will. The guide for married couples explains how beneficiary forms interact with the will.

Farms and family businesses

A farm or a business is often the largest asset and the least liquid. Federal law has special provisions for qualified real property used in farming or a closely held business, which can allow the estate tax to be paid in installments over a long period instead of all at once. Keeping the enterprise running through a trust and planning who will take over the operation are as important as the tax mechanics. The estate planning section covers how a trust can hold operating assets so a business does not stall.

What to do, and what to avoid

Start with an inventory: what you own, how it is titled, what it is worth, and what it cost. That last number, the basis, is the one families usually forget and the one that decides the income tax. Then ask a lawyer and an accountant to look at the whole picture together. Avoid moving assets before you understand the basis, and avoid signing a trust or an insurance product sold as a tax cure without a second opinion. Most Iowa estates need a clear will, current beneficiary forms and a sensible plan for the house. Only a few need anything more ambitious.

IRS guidance on estate and gift taxes and Iowa Department of Revenue information underlie this page. Tax rules change, so confirm current figures with the agency or a licensed professional. This is not tax advice.