Preparing for upcoming estate tax law changes
Since 2018, Americans have enjoyed a significant increase in the size of decedents’ estates that are not subject to federal estate taxes, but that time may be coming to an end. Taxpayers who died in 2017 had a lifetime estate and gift tax exemption of $5,490,000. This meant that during the life or upon the death of the taxpayer, each taxpayer was able to give away, as lifetime taxable gifts and by their estates at death, a total of $5,490,000 with no tax liability.
The Tax Cuts and Jobs Act of 2017 nearly doubled the exemption amount from $5.6 million to $11.18 million (in 2018), indexed for inflation. The current exemption amount is $12,920,000 (in 2023). However, under the terms of the Act, the increase in the exemption amount will only be extended through December 31, 2024. Unless further congressional action is taken, the Act will “sunset” and on January 1, 2025, the exemption will return to its previous amount, which should be approximately $7 million after it is indexed for inflation. In addition to the scheduled exemption decrease, the maximum gift and estate tax rate will increase from 40% to 45%. This means that every dollar of estate value that exceeds the exemption amount will be taxed at a progressively increasing tax rate that tops out at 45%. For reference, the maximum federal income tax rate for an individual is currently 37%.
High-net-worth individuals who relied on the increased exemption amount as part of their estate planning should reevaluate those plans given the uncertainty of the future of the lifetime exemption. However, with proper planning, there are a number of techniques that may be used to lessen or eliminate the tax burden that may be due as a result of one’s death. While a general overview of some of these techniques are discussed below, you should consult with an estate planning attorney before changing your current estate plan.
One common method of reducing gift and estate tax liability for married couples is to take advantage of the portability of the Deceased Spouse’s Unused Exemption (DSUE). When one spouse dies, the surviving spouse may elect to capture their spouse’s unused exemption amount and add it to their own future exemption amount. For example, if a husband dies in 2023 and has not used any of his $12,920,000 exemption, his wife can choose to add that unused amount on top of her own exemption. If the wife dies after January 1, 2025 and we assume that her exemption amount is about $7 million, her estate will have a total exemption amount of about $20 million. Under current IRS regulations, a surviving spouse has five years from the date of the deceased spouse’s death to claim the DSUE.
From a planning perspective, trusts are frequently used to take property out of a person’s taxable estate. While there are many types of trusts that may be used, one type of trust is the Spousal Lifetime Access Trust (SLAT), wherein one spouse, as donor, makes a gift of money or property to an irrevocable trust for the benefit of the other spouse, as donee. While the gift itself is counted against the donor spouse’s lifetime exemption, any income that the SLAT produces will be excluded from both spouses’ estates for federal estate tax purposes. However, the SLAT’s income will be taxed as if it were the donor spouse’s income, but as discussed above, individuals are generally taxed at a lower rate than trusts and estates. If the amount being taxed cannot be reduced, decreasing the rate at which the amount is being taxed will result in lower taxes.
Tax-saving techniques that may be used in one’s estate plan may or may not be right for everyone, so it is important to discuss your estate plan and tax objectives with a well-qualified estate planning attorney. With the upcoming tax law changes, it would be wise to review your current estate planning documents.
Nothing contained in this publication should be considered as the rendering of legal advice to any person’s specific case but should be considered general information.