Estate Strategies: Maximizing Wealth, Minimizing Taxes

For 2024, estates exceeding $13,610,000 (or $26 million for married couples) may be subject to estate taxes, making strategic planning essential for wealth preservation, and this number could be even higher in 2025.

In today’s episode of Retire in Texas, PAX Financial Group CEO and Co-Founder, Darryl Lyons, dives deep into the intricate world of inheritance and legacy planning, shedding light on key tax considerations that can significantly impact your estate and the wealth you pass on to the next generation.

Some of today’s show highlights include:

*A breakdown of the immense tax benefits of living in a Community Property State.

*Why it’s vital to differentiate between ordinary income and capital gains in inheritance.

*Understanding the key differences between estate taxes and income taxes.

*The valuable tax provision that is Step-Up in Basis.

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Hey, thanks for tuning in today. This is Darryl Lyons, CEO and Co-Founder of PAX Financial Group. This information is general in nature only. It’s not intended to provide specific tax, investment, or legal advice. Visit PAXFinancialGroup.com for more information.

So, can I start out with just a quick, dose of humor? So, my friend Dave, he’s a single guy living at home with his father, working in the family business, and he knew that he’d inherit a fortune once his sick father passed away. So, Dave wanted two things. He wanted first, to learn how to invest his inheritance, and then second, he wanted to find a wife to share his fortune with.

So, one evening at an investment meeting, he spotted the most beautiful woman he had ever seen. Her beauty took his breath away and he said to her, I may look just like an ordinary man, but in a few years my father will die, and I’ll inherit $20 million. She was very impressed. So, she asked for his business card.

Two weeks later, she became his stepmother. I thought that was a funny joke. I hope it made you chuckle a little bit, but we’re going to talk a little bit about inheritance today. Now, there’s so many different ways to discuss this, certainly philosophically. Certainly, biblically contractual law. I’m actually going to just touch on taxes today, and I want to give you six points that you just need to make sure you don’t have confusion on, because if you don’t get these if you don’t understand these six elements when it comes to inheritance and any component of these six points that I’m about to make are confusing, you could trip and fumble and pay more to the

IRS than you want to. Now, it is not uncommon. It is not uncommon for somebody to say, I’m not going to mess with it. I’m going to let my kids figure it out. I’ll let or here’s another phrase I’ve heard. I’ll let them worry about it. And I know that I mean, if we’re intellectually honest with ourselves, we know that we’re just avoiding what may be discomfort or to some degree confrontation if we’re honest with ourselves.

Because the reality is there will be a meeting about money. It’s whether or not you’ll be there or not. So, I would suggest that if there isn’t any inheritance, that there is a meeting and conversation. Otherwise, I wish I had the statistics, but my experience has been siblings tend to stop speaking to each other because of the conflicts that come with an inheritance.

This podcast is not going to cover how to resolve those conflicts. It’s going to help you understand how to reduce any potential tax liability. But I need to cover this piece today because I’ve never covered it before. So, there’s six elements I want to cover with you. The first one is I need you to understand the word basis.

You might have heard the word basis. You guys like and you understand, that’s really basic. Okay, hang with me. But just to be very clear, if you own a piece of property and you bought it and let’s say you paid 500,000 for it, we’ll say you bought it in La Vernia just to kind of create an imagery. If you’ve been to La Vernia, there is actually some rolling green hills.

I think it’s a nice, understated part of South Texas. In fact, I think a lot of people are now moving out there. But 500,000 is what you bought for this property, right? So, you bought some land and you drove some cattle on there or maybe a blind or two, but you bought it for 500,000 and now you bought it.

Let’s say, you know, pre-COVID and now it’s worth 750,000. So, the basis is what you paid for it, the 500,000. Now the IRS has some modifications to this number. So that’s why the term isn’t just, hey, why did you pay for it? When it comes to accounting, it’s basis. That’s the accounting word, because there are some adjustments that are made throughout the lifetime of that property.

But just know, basis is, generally speaking, what you paid for it. Okay. So that’s number one. Number two, you need to know what step up in basis is. Step up in basis. So, step up in basis is really, really helpful. And actually, politically, I’m starting to see some politicians talk about getting rid of this tool called Step up in basis.

So, like I mentioned, in the La Vernia land, you would pay taxes if you sold that property, you paid your $500,000 basis, you sold it for 750, you have a $250,000 gain. You’re going to pay taxes on that. But at death, you get a step up in basis. So, your basis is no longer 500,000, it’s 750, it’s steps up.

So, if you sell it the next day or your kid sells the next day, there’s really just no taxes on it. It’s a really amazing section of the tax code, the step up in basis. It’s like a reset of the basis at death. It’s a reset and it’s awesome. Now, I have seen a situation just recently where there was no documentation of the new value at death.

And so, you’ve got to make sure that that it is reappraised at death to get this step up in basis. But the step up in basis is a really, really excellent part of our tax code, which is I think some people are looking at, you know, doing away with that. Number three, you need to know if you’re community property or not.

Now, Texas is a community property state, which is really cool. So, what does that mean? So, some people ask me how much in taxes would my wife or my husband pay if I were to die? So, the good news is you can transfer money by gift or by death without any tax consequences between married couples. So that’s really cool.

So, in a community proper state, there’s no tax issue when receiving property. In fact, there’s a really, really cool step up in basis feature. I won’t get into it, but it’s a really cool step up a basis feature on community property that’s a benefit that other states don’t get. It’s a really cool, attractive feature. In fact, so cool that some people will actually strategize if they’ve got a lot of money that they’re going to leave to their spouse, they’ll actually move to a community property state because of this very attractive tax feature that if I got into it, it would be confusing.

But you can look it up if you want to just know if you’re in a community property state, you can move money between spouses. There’s, you know, when you pass away, your spouse is not going to have to pay income tax on the property, generally speaking. So, number four, you’ve got to be aware of ordinary income taxes versus capital gains.

Now, most of the time when an asset is left to the next generation through an inheritance or death, you get this step up in basis, which is really cool. But you got to know what a capital gains versus ordinary income, because there are some there are some assets that can be left to the next generation that are ordinary income, and you don’t get this step up in basis thing like an annuity.

Annuities are really, they’re really not great tools to leave to the next generation. Now I say all that, but the annuity companies know that they’re not good tools, so they’ve added some features that make them advantageous. It’s again, a separate point, but just generally speaking, there are few assets out there that you don’t get this step up in basis.

And I don’t want any surprises. IRAs generally traditional IRAs or that way, generally speaking. So not everything gets this capital gain or step up in basis treatment a lot. There’s a handful of ordinary income assets out there and ordinary income is generally higher in their tax rates. Okay. Number five, a lot of people get confused about income taxes versus estate taxes.

So maybe they’ll ask me the question, hey, do I is there any taxes upon our death? And then the next question I would ask is, are you asking about income taxes or estate taxes? Now, what’s cool about Texas is there’s no death tax. Other states have death taxes or inheritance taxes. I’m trying to think there’s a state tax.

They call them different things. But generally speaking, it’s like there’s a federal estate tax and then some states have their own death tax. Texas does not have its death tax, but there is a federal one. So, some people kind of get confused, especially when you get into the political stuff. As we get into this political season, try to try to differentiate between estate tax and income tax.

Income tax, but an estate tax is assessed when the value of the estate exceeds $13,610,000. That’s 2024. That’s for a single person. So, if you’re married, you double that number and anything under that 26 million is not subject to an estate tax. So, if you’re under 26 million in your entire estate, you’re probably pretty good. Now, don’t forget life insurance, death benefits are included in that number, but you’re pretty good right now.

We’ve got to pay attention to the upcoming elections because in 2025, there are some tax cuts that will be reassessed. They have to be, I guess, reconstituted. And this 26 million could change real quick. So don’t just anchor to that, but just know that if your estate currently is under 26 million, generally, you’re not going to pay an estate tax.

So, you can kind of not worry about that piece of your estate right now, but you still need to think about the income tax that may be due to your beneficiaries. And those typically are associated with those ordinary income pieces of assets, IRAs, annuities, but not estate tax. So that’s good. Number six, you need to know what assets are tax free at death.

So, there’s some tax-free assets. Now, when I say tax free, I’m talking about income tax free. They could still be subject to an estate tax. But if you’re under 26 million, you don’t have to worry about that. But they’re generally income tax free and that’s oftentimes life insurance. So, life insurance is generally tax free, which is really cool.

It’s one of the most tax efficient vehicles out there. And then Roth IRAs, now Roth IRAs, you are required your beneficiaries are required to take out distributions so they can’t keep it forever like they used to call a stretch IRA. But yeah, so the is there a couple assets that are completely tax free. So, they’re really cool. Now I think the Roth IRA is worthy of consideration if you’re going to leave money to the next generation and you’ve got maybe old 401ks that are in traditional IRAs, talk with your advisor about converting those to Roth IRAs.

You would convert them and basically, you’re prepaying the taxes for the kids. And that may be a good strategy. Again, a lot of these considerations are really designed about not making your kids’ lives easier necessarily. When we talk about income taxes, we’re talking about how can we pay less to the IRS? So, the idea of converting to a Roth is not to try to make your kids more wealthy.

I know that’s ultimately going to be going to happen if you’ve got a lot of money, But it’s actually saying, okay, I don’t want to pay the IRS a lot of money. I don’t want my kids to pay the IRS a lot of money. I worked hard for this money. I do not want to give them more.

I don’t want to leave them a tip by any means. So, the strategy here is just saying I really want my hard-earned money to go as much as possible to my kids or to the next generation and as little as possible to the IRS. And so that’s why you consider even converting today the Roth, your traditional IRAs to a Roth, because it’s not necessarily to make your kids wealthier, but to just say, I do not like the IRS, and I don’t want them to get more money.

So, the Roth IRA conversions, check with your advisor on that. And you want to check now because again, there’s some elections coming up and there’s some tax code changes. So, it might be advantageous, depending on your bracket, to convert in the next couple of years. So, generally speaking, this information has a lot of exceptions to exceptions.

That’s just how the IRS code works. And, you know, you have to check with your tax advisor too, you know, double click on all this stuff and make sure it makes sense for you. And if you understand these six generalities in the inheritance tax world, I think it’ll help you. So, in summary, make sure you know the word basis, be familiar with step up in basis.

Number three, understand that in a community property state, there’s no tax between spouses. Number four, be aware of ordinary income versus capital gain assets. Number five, don’t confuse income tax with the state tax. And number six, know what assets are tax free at death. So if you can understand those six elements of an inheritance and then you speak with your advisor, I think y’all will be able to create a strategy that makes sense, that will hopefully disinherit the IRS when it comes to your estate and I think I’ve mentioned this a thousand times before, when you think about it, inheritance, think about it through this lens.

That inheritance is what you leave to someone, but a legacy is what you leave in someone. So be thoughtful, be considerate, be intentional about the legacy you leave to the next generation. Thank you for listening today. As always, make sure you share this with others. I’m told that you have to like and subscribe, so do that as well.

And as always, you think different when you think long term. Have a great day.

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