Troubleshooting Legal Problems

Can a trust be used to avoid inheritance tax?

There’s a big misconception out there about trusts and what they can (and cannot) do for an estate. A lot of people think that trusts can be used to avoid inheritance taxes – but that’s not actually true.

Trusts can be used to minimize (and sometimes avoid) estate taxes. However inheritance taxes are not the same thing.

What’s the difference between an estate tax and an inheritance tax?

Estate taxes are taxes paid on behalf of the deceased. They come out of any assets the deceased left behind. Inheritance taxes, by comparison, are taxes levied against the assets received by someone’s heirs.

The vast majority of states don’t have an inheritance tax, but Pennsylvania does. According to the statute, jointly owned property by spouses is exempt from any inheritance tax, as is property that is inherited directly from a spouse. So is property that is inherited by a parent after a child 21 years of age or younger passes away. For all others, the tax rate is as follows:

  • 5% on inheritances by direct, lineal heirs
  • 12% on inheritances by siblings of the deceased
  • 15% for all other heirs (except charitable organization and certain exempt entities)

There are distinct strategies for reducing or eliminating inheritance taxes for your heirs, including making use of annual gifts, buying property in a state without an inheritance tax and using joint accounts. However, a trust isn’t a “quick fix” for the inheritance tax problem your heirs could face.

What’s the point of having a trust, then?

Trusts have a multitude of other uses. With the right planning and some experienced legal guidance, you can use certain kinds of trusts to minimize your estate taxes and protect your assets from creditors or misuse. You can also set up a trust so that it doles out an inheritance according to predetermined conditions (which can keep the money or assets out of immature hands) or protect them from an heir’s divorce.

Estate planning can be a complicated process, especially when you’re thinking ahead about the potential ways you can reduce your family’s tax burden once you are gone. Learning more about your available options is wise.