How to Prepare for Upcoming Estate Tax Law Changes

High-net-worth families have time to take advantage of higher estate and gift tax exemptions before they’re significantly reduced if provisions of the Tax Cuts and Job Act are allowed to sunset.

Unless Congress acts, on Jan. 1, 2026, the estate, gift and generation-skipping transfer (GST) tax exemption amounts will be cut in half. A decrease in the exemption amount could result in significant additional transfer taxes for families with federally taxable estates. However, there is still ample opportunity for high-net-worth families to plan to utilize the current exemption amounts. This article will explore potential wealth transfer opportunities to capture and utilize the exemption amount before it may be lost.

In 2017, the Tax Cuts and Jobs Act (TCJA) doubled the existing estate and gift tax exemption amounts from $5.6 million per person (or $11.18 million per married couple) to $11.18 million per person (or $22.36 million per married couple), indexed for inflation annually. In 2023, the estate and gift tax exemption amount is $12.92 million per person (or $25.84 million per married couple).

The TCJA is set to expire at the end of 2025. Let’s assume that the estate and gift tax exemption amount has increased to $14 million by this time (due to adjustments for inflation). In that case, if Congress does not act, the exemption amount would decrease to about $7 million per person or $14 million per married couple. This loss in exemption amount could increase overall transfer taxes for certain families by millions of dollars.

Wise move: Explore options well before 2026

We’ve been in a similar position in prior years and have seen that congressional gridlock can make reaching an agreement on preserving or increasing the exemption extremely difficult. While it is uncertain what, if any, tax-related legislation will come out of Congress in 2024 and 2025, it may be wise to explore one’s options to use the current existing exemption well before 2026.

If you can afford to use a portion or all of your existing exemption amount before Jan. 1, 2026, the amount used now cannot later be taken away from you. It has also been confirmed that if you use more exemption during life than is available at death (due to the decrease), the IRS cannot impose estate tax on those “excess” gifts as part of the taxpayer’s taxable estate when they pass. (Please note that there are some minimal exceptions to this rule for certain types of gifts made within three years of death.)

In addition, it’s important to note that when using your exemption during your life, you use it from the “bottom up.” This means that if you have $12.92 million of exemption and you use $6 million by making a gift (leaving you with $6.92 million), if the exemption amount is then cut in half, the $6 million of exemption you have used is considered to come out of the remaining amount, not the amount that was taken away.

In the above example, if you make a $6 million gift and the exemption amount is cut in half from $14 million to $7 million, you will have only $1 million remaining for future gifts or to shield assets from taxes upon your death. Consequently, locking in the exemption amount that may be taken away requires large gifts close to or at the full exemption amount before the amount potentially drops.

Estate planning strategies for gifting

Below are some estate planning strategies for gifting to discuss with your advisers:

  • Spousal lifetime access trust (SLAT). It is possible to create an irrevocable trust for your spouse, gift assets into it and use your exemption amount. While this type of trust offers great flexibility by allowing the non-gifting spouse to be a trust beneficiary of income, there are several potential issues with this trust. Divorce from your spouse or the untimely death of a spouse are two of the main pitfalls. There are additional complexities to this type of trust. It is important to go over all possible ramifications with your advisers when considering a SLAT.
  • Irrevocable trusts for children/descendants. You can create an irrevocable trust or trusts for the benefit of younger generations and utilize your existing gift and GST tax exemption amount, if desired. Consider a Crummey trust or other discretionary irrevocable trusts for descendants to gift assets you anticipate will appreciate greatly. By taking advantage of transferring or gifting assets (and their future appreciation) now, you use an exemption amount you would otherwise lose after the sunset.

Don’t overlook this possible additional benefit

As an added benefit, if you live in one of the 12 states (or the District of Columbia) that has a state-level estate tax, gifting will typically reduce the amount of state estate tax owed when you pass.

If the loss of the current transfer tax exemption amounts could negatively affect your family, we recommend you speak with your wealth planning advisers and your estate planning attorney to discuss if the existing planning opportunities would be right for your individual situation.

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