Taxation & Legal Considerations Flashcards

What is estate tax?

Answer: Tax on asset transfer at death

Estate tax is a federal or state tax levied on the total value of a deceased person's assets before they are distributed to heirs. It is a tax on the privilege of transferring property at death, rather than on the inheritance itself. The tax applies only to estates exceeding a certain exemption threshold, and careful estate planning can help minimize its impact.

What is gift tax?

Answer: Tax on property transferred during life

Gift tax is a federal tax imposed on the transfer of money or property from one person to another while the giver is still alive, without receiving full value in return. The purpose is to prevent individuals from avoiding estate taxes by giving away all their assets before death. There are annual exclusion limits and a lifetime exemption amount that allow for tax-free gifting up to certain thresholds.

What is a power of attorney?

Answer: Authorization to act for another

A power of attorney (POA) is a legal document that grants one person (the agent or attorney-in-fact) the authority to act on behalf of another person (the principal) in specified matters. This authority can be broad or limited, covering financial, medical, or other legal decisions. It is a vital tool for managing affairs if the principal becomes unavailable or incapacitated.

What is capital gains tax?

Answer: Tax on profit from asset sale

Capital gains tax is a tax levied on the profit realized from the sale of a non-inventory asset, such as stocks, bonds, real estate, or other investments. The gain is calculated as the difference between the asset's selling price and its original purchase price (cost basis). This tax is an important consideration in investment and estate planning, as inherited assets may receive a 'step-up in basis' which can reduce future capital gains liability for heirs.

What is probate?

Answer: Will validation process

Probate is the legal process that validates a deceased person's will and oversees the administration of their estate. During probate, the court confirms the will's authenticity, identifies and inventories the deceased's assets, pays off debts and taxes, and then distributes the remaining property to the rightful heirs or beneficiaries. This process ensures the orderly transfer of assets according to legal requirements.

What is a living trust?

Answer: Trust created during life

A living trust, also known as an inter vivos trust, is a legal document created by an individual during their lifetime to hold and manage their assets. The grantor typically acts as the initial trustee and beneficiary, maintaining control over the assets. Upon the grantor's death, the trust assets are distributed to beneficiaries without going through the public and often lengthy probate process, offering privacy and efficiency.

What is a beneficiary designation?

Answer: Naming recipients for accounts

Beneficiary designation is the act of specifically naming individuals or entities who will inherit assets from certain financial accounts, such as life insurance policies, retirement plans (IRAs, 401(k)s), and bank accounts. These designations allow assets to pass directly to the named beneficiaries upon the owner's death, bypassing the probate court process. This ensures a swift and private transfer of these specific assets.

What is a fiduciary duty?

Answer: Acting in best interest of others

A fiduciary duty is a legal and ethical obligation to act solely in the best interests of another party, known as the beneficiary or principal. This duty requires the fiduciary to prioritize the beneficiary's welfare above their own, exercising loyalty, care, and good faith. Examples include trustees managing assets for beneficiaries or financial advisors guiding clients.

What is the purpose of tax planning in estate management?

Answer: Minimize taxes and preserve wealth

The primary purpose of tax planning in estate management is to strategically minimize the various taxes associated with wealth transfer, such as estate, gift, and generation-skipping transfer taxes. By employing legal strategies like gifting, establishing trusts, and utilizing exemptions, individuals can preserve a greater portion of their wealth. This ensures more assets are passed on to beneficiaries, aligning with the estate owner's wishes.