The federal estate tax exemption is at a historic high but soon will be cut in half. The Tax Cuts and Jobs Act passed in 2017 doubled the federal estate tax exemption from $5 million to $10 million (adjusted for inflation). In 2023, the per-person federal estate-tax exemption has grown to $12.92 million, which means that a married couple can pass a record of nearly $26 million to their family and other loved ones without paying any federal estate tax. However, without congressional action, at the end of 2025, the federal estate tax exemption will be reduced to approximately $7 million per individual pending final inflation adjustments due to a “sunset” provision in the Tax Cuts and Jobs Act.
While many American families will still be exempt from paying federal estate tax in 2026, some wealthy families may be caught off guard by this monumental change.
What can you do to prepare?
Define your ultimate wealth-transfer vision:
If you find yourself facing a potential estate tax when the law changes, determine how much of your wealth you want to leave to your family. Keep in mind that there are three potential beneficiaries of your estate plan: your family and other loved ones (often the most important), charitable beneficiaries, and of course, the federal government.
Most people would prefer the government weren’t a beneficiary of their wealth, but you need to determine if maximizing the amount of after-tax wealth for your family is a priority for you. Some would say “Yes!” But a fair number of wealthy families may prefer to leave a relatively modest portion of their estate to their children and the rest to their favorite charitable causes. If the “right” amount of money left to your family is less than or equal to the future estate tax exemption after the deduction for charitable endeavors, then the pending changes to the federal estate tax laws may not be an issue for you.
Lifetime gifting strategies:
If the amount of wealth you want to leave to your family either exceeds or is projected to exceed the federal exemption in the future, then you still have time to do proactive lifetime gifting. Remember, the federal estate tax exemption is in place until the end of 2025.
To take advantage of the historically high estate-tax exemption, you can gift a large portion of your assets to your family. However, the gift must be substantial. To obtain any benefit, you must gift property in excess of the threshold for estate tax after sunset, which is estimated to be at least $7 million at the end of 2025. Such large gifts should not be taken lightly because gifting is an irrevocable decision that results in a loss of control of the assets and loss of certain tax benefits like a step-up in cost basis at death.
One potential strategy to consider is the use of what is commonly called a spousal lifetime access trust or SLAT. One or more SLATs generally allow each spouse to set up an irrevocable trust for the benefit of the other spouse. This way the couple can retain use of the assets indirectly as beneficiaries while removing the gifted assets from the transferor’s taxable estate, thus locking in the higher exemption before it is cut in half in 2026. Be sure to pay careful attention needs to the trust design to avoid inadvertent inclusion in the estate for estate-tax purposes and the strategy also has other drawbacks that should be carefully reviewed by an estate planning professional.
If gifting all or a substantial portion of your estate in the near future makes you uncomfortable, especially with so much uncertainty — you are not alone. Aggressive gifting may not be a good solution for you right now, but you can still manage your future estate-tax bill by making gifts over time using strategies such as qualified personal residence trusts, irrevocable life insurance trusts, grantor retained annuity trusts, family limited partnerships, and even split-interest charitable trusts – like charitable lead annuity trusts and charitable remainder trusts.
If you don’t have an estate-tax problem, are uncomfortable making very large gifts, or just want to keep things simple to start, you can also take advantage of the annual gift tax exclusion, which is $17,000 per gift recipient. If the amount of a gift exceeds $17,000, you will need to file a gift-tax return, and any amounts over $17,000 will count against your estate-tax exemption at death. You can also make unlimited gifts by paying medical or tuition expenses on behalf of a loved one directly to a healthcare provider or an educational institution.
What about state-based estate tax?
While the federal estate tax certainly receives the most media attention, some states have a state-based estate tax that, in many cases, results from much lower state estate tax exemptions. At present, 12 states and the District of Columbia have an estate tax that applies at death: Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. Other states such as Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania have an inheritance tax. Maryland uniquely has both an estate tax and an inheritance tax.
If you live in a state that has an estate tax, you should plan carefully to minimize the effects of state estate tax. Some families may decide to relocate to lower-tax states altogether.
Don’t overlook the basics.
It can be easy to focus on taxes but don’t forget to make sure you have a good estate-planning foundation. Often, families forget to review their basic estate plan documents, the terms of which can become outdated due to changes in law or personal family and financial situations. Other frequently overlooked critical points include misaligned beneficiary designations on life insurance policies and retirement accounts like 401(k)s and IRAs, and mistitled assets that can unexpectedly cause an estate to be subject to unnecessary income tax and administrative delay and expense, such as through court-involved administration commonly referred to as probate.
Estate plans should be reviewed periodically and potentially updated whenever you experience a key life event – like the death of a loved one, birth of a child or grandchild, change in state residence, or other event like a major change in estate and income tax rules.
Planning ahead is always the best approach, and even more so, as the pending sunset provisions in the 2017 Tax Cuts and Jobs Act will soon be upon us.