Wealth taxes do not only include income tax.
Did you know that there are different types of taxes for high net worth individuals?
Among the many types of “wealth” taxes, some of the largest tax bills can be sourced to estate tax, gift tax, trust tax and alternative minimum tax.
Understanding the different types of wealth taxes is important if you want to maintain maximum control of the wealth you accumulate.
What are Wealth Taxes? First, Understand High-Net Worth
To understand how the wealthy avoid taxes, you must first understand “high-net-worth” – the term he IRS and SEC use to define the “wealthy”.
Are you a high net worth individual (HNWI)?
If you are not sure, take a look at sec.gov. Here are two qualifications of a HNWI, according to the U.S. Securities and Exchange Commission (SEC):
- a natural person who, or a company that, immediately after entering into the contract has at least $1,100,000 under the management of the investment adviser; or
- a natural person who, or a company that, the investment adviser entering into the contract (and any person acting on his behalf) reasonably believes, immediately prior to entering into the contract, has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than $2,200,000.
If you meet these qualifications – or you see yourself as a future HNWI , then you need to be aware of the wealth taxes that may apply to you.
1. Alternative Minimum Tax
By definition, anyone subject to the AMT in 2023 must have more than $81,300 in taxable income (if single), or more than $126,500 if married and filing jointly.
Here is an example of how the AMT works – let’s say you own a home or rental property and have taken out a mortgage on it, you are allowed to deduct the interest paid on that loan from your taxable income when filing your taxes. However, this deduction only applies in certain circumstances; for example it does not apply for anyone subject to the AMT.
To avoid AMT, you have to reduce the amount of money you make. AMT tax strategies include making donations to charity, purchasing municipal bonds (which are tax-free) and other strategies that do not influence the amount of taxable income that you earn.
Keep in mind, if you’re not liable for AMT this year, but you paid AMT in one or more previous years, you may be eligible to take a special minimum tax credit against your regular tax this year.
If eligible, you should complete and attach Form 8801, Credit for Prior Year Minimum Tax – Individuals, Estates, and Trusts to claim the minimum tax credit.
2. Trust Tax
Trusts can be used for business planning, asset protection, or to save income and estate taxes. While the nuances of trust tax law are complex, trusts are often taxed at their own rates, as corporations or as “flow-through” entities (passing tax liabilities through to the beneficiaries, who then pay taxes on their individual returns).
Although trusts can be strategic tax tools, know that they can also reach high tax rates at low income levels. For tax year 2023, trusts with income over $14,451 may face a top tax rate of 37 percent.
Since trusts are separate tax entities with their own assets, liabilities, expenses and income, trusts have to file a return—the form depends on what type the trust is.
3. Estate Tax
Under current law, most HNWIs will not need to worry about a federal estate tax.
The estate tax is applied after you pass. It is a tax on your gross estate, plus adjusted taxable gifts.
The good news is, for tax year 2023, all taxpayers receive a lifetime exemption of $12,920,000 (double if you are married).
So, if the value of your gross estate (real estate, investments, art, jewelry, etc.) is below the lifetime exemption when you pass, you are most likely exempt from the estate tax.
When your estate exceeds the lifetime exemption, however, the assets in your estate are subject to a progressive tax rate as high as 40%.
This tax is separate from your final income tax liability. It is possible to owe both income and estate tax upon your passing.
To reduce estate tax, high net worth individuals can move items out of their state with trusts and gifting.
These individuals should consult an Estate Planning Attorney and a CPA to develop the best strategy to minimize estate, gift and generation-skipping tax and effectively pass on generational wealth.
4. Gift Tax
High net worth individuals that try to avoid estate tax by gifting away all of their wealth could subject themselves to the Gift Tax.
According to the IRS, a gift is –
any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.
A gift can be cash, real estate, stock, an NFT, business interest or any other asset.
These gifts are computed in aggregate. For instance, if you give a friend $5,000 every month, then for gift tax purposes, your annual gift was $60,000.
The general rule is that any gift that exceeds the annual exclusion amount is a taxable gift. For 2023, the annual exclusion amount is $17,000.
- Tuition paid directly to a qualifying educational institution.
- Medical expenses paid directly to a care provider.
- Gifts to your spouse.
- Gifts to a political organization for its use.
- Gifts to qualifying charities.
In addition to this, gifts to qualifying charities are deductible from the value of the gift(s) made.
Taxable gifts are subject to a lifetime exemption amount. Gifts that exceed the lifetime exemption are subject to a progressive tax rate as high as 40%. In 2022, the gift tax and estate tax lifetime exclusion amount is the same.
So, even though you might have to complete a Gift Tax Return for a gift over $17,000, you might not be subject to the gift tax if the total value of your lifetime gifts is less than the annual exemption.
5. Generation-skipping Tax (GST)
Some high net worth individuals plan to leave assets to their grandchildren to prevent their direct children from being subject to an estate tax on their inheritance.
The IRS imposes a flat 40% tax on these transfers that skip a generation. The tax is called a generation-skipping tax (GST). The GST applies to assets gifted to a “skip person.” According to the IRS, a skip person is:
- A natural person assigned to a generation that is two or more generations below the settlor’s generation, or
- A trust that meets either of the following conditions:
- All interests in the trust are held by skip persons; or
- No person holds an interest in the trust, and at no time after the transfer to the trust may a distribution be made to a non-skip person.
Similar to the estate and gift tax, the 2023 GST is also subject to a $12,920,000 exemption.
GST and the gift tax can get quite complicated – particularly when spouses split gifts and when allocating exemptions. Adequate estate and trust tax planning can help you reduce or eliminate these taxes.
Conclusion
If you want to accumulate wealth and avoid taxes, you must plan for all types of wealth taxes.
Fortunately, there are many legal strategies – such as charitable giving, stategic trust creation, etc. – to reduce the amount of tax levied against your wealth.
Often, this type of planning goes beyond the IRS tax code. You should consider hiring licensed estate planning, HNW tax accountants, and other advisors that specialize in this area.
And, as always, remember to steward your wealth wisely!
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, investment or accounting advice. This information is not endorsed by a financial institution. You should consult your own tax, legal and accounting advisers before engaging in any transaction.
