Why You Might Have an Estate Tax Issue Soon
The Countdown Begins: Will We Keep the $10 Million Exemption?
The year 2026 is quickly approaching, bringing substantial changes that may affect your estate tax situation. The Tax Cuts and Jobs Act (TCJA) in 2017 significantly increased the federal estate tax exemption to $10 million adjusted for inflation. This is the amount you can gift or leave to your loved ones at your death without incurring a gift or estate tax liability. Any portion of the exemption used during lifetime reduces the total exemption amount available at death for estate tax purposes.
However, the countdown has begun for the potential sunset of this generous exemption by the end of 2025. Adjusting for inflation, the Congressional Budget Office estimates the new exemption amount will be $6.4 million in 2026.1 There are strong arguments for and against the changes in legislation. Whether the current exemption amount remains or is reduced to roughly $6.4 million, valuable insights from professional advisors can prepare you for either scenario. What is not taxable today might be taxable tomorrow.
History of the Estate Tax Exemption
The federal estate tax was first enacted in 1916 to generate revenue for the government. Over the years, it has undergone various changes in exemption limits and rates.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) gradually increased the estate tax exemption and reduced the tax rate until it reached zero in 2010.2 However, the estate tax was set to return to the 2001 amounts for deaths occurring in 2011 unless further legislative action was taken.3 In 2011, the estate tax exemption was reinstated at $5.0 million.4
In 2017, the TCJA doubled the estate tax exemption from $5.49 million to nearly $11 million to stimulate economic growth and create jobs.5 The exemption continues to adjust for inflation, offering individuals an unprecedented opportunity to pass on substantial wealth free from federal estate tax.
The TCJA’s Sunset Provision
A sunset provision was embedded within the TCJA to limit how long the higher estate tax exemption could continue. Without legislative intervention, it will be cut in half to $5 million adjusted for inflation in 2026, creating a potential estate planning crisis for people with considerable estates on December 31, 2025. Adjusting for inflation, the Congressional Budget Office estimates the exemption amount will be $6.4 million in 2026.6
If We Keep the Current Estate Tax Exemption
Maintaining or increasing the already high estate tax exemption amount could be seen as a move that benefits the wealthy, broadening the tax burden for others. It can also be seen as maintaining the status quo. And the current law ensures that most people will not be subject to federal estate taxes.
A higher estate tax exemption was expected to foster economic growth and capital investment by allowing wealthier individuals and families to reinvest in businesses and job creation.7 Yet the federal government relies on estate tax revenue to fund various programs and therefore would not want to reduce a lucrative revenue source. Without the estate tax, other revenue sources would have to foot the bill for these programs and potentially face cuts in the benefits and services provided.
For the estate tax exclusion to remain at the higher amount beyond 2025, Congress will need to take action.
Why the Estate Tax Exemption May Revert Back
The TCJA was part of a short-term tax cut package. Lawmakers had to make room in the budget for the tax cuts introduced by the legislation.8 They did this by temporarily increasing the estate tax exemption.
Reverting to a lower exemption amount is believed to generate more revenue by increasing the number of people who pay the tax and increasing estate tax exposure to those with net wealth above the current exemption amount. Estate tax revenues are projected to increase sharply after 2025, when the exemption amount is scheduled to drop. From 2021–2031, the combined estate and gift tax revenues are projected to total $372 billion.9
Preparing for Potential Estate Tax Changes
As we move into 2024, it is crucial to review estate planning goals and strategies that may be affected by potential changes in the federal estate tax exemption law. By working together with your other trusted advisors, we can reevaluate your current estate plan, investments, and property to ensure that you are protected and your financial legacy is preserved.
Case Study: How Concerned Should You Be about Estate Tax Issues?
If you have significant wealth, you may be exposed to future estate tax burdens that must be acted on before the Tax Cuts and Jobs Act reduces the estate tax exemption in 2026. Developing and implementing the right estate planning and tax strategies takes time. You may need to prepare regardless of whether the estate tax continues at its current level or if it is cut in half. This means strategizing to minimize your estate tax liability now.
Does This Sound Like You?
Meet the Andersons, a well-off family living in a state with a high cost of living. Robert Anderson, the father, is a successful entrepreneur who built a thriving business over the years. His wife, Sarah, is an accomplished artist, and together they have accumulated a substantial estate of $8 million each, for a total of $16 million. Their estate is primarily composed of their business assets, valuable artwork, life insurance, a family residence, a vacation home, and other lucrative investments. They have two adult children, James and Emily, both actively involved in the family business.
Their Unique Estate Tax Situation
With the generous federal estate tax exemption set at $10 million adjusted for inflation per individual in 2017, steadily increasing to $13.61 million in 2024, the Andersons have felt relatively secure about avoiding estate taxes. Their primary concern has been preserving the family legacy and ensuring a smooth transition of their assets (business, accounts, and property) to the next generation. They had taken some initial estate planning steps, such as creating a will, discussing the use of a family limited partnership, and exploring gifting strategies to transfer the assets to their children gradually.
If the estate tax exemption drops to $5 million adjusted for inflation, the Andersons may face several estate tax issues that require professional advice and assistance before the end of 2025. The Andersons need to find other ways to protect their money and property.
Business Succession Planning
The family business represents a significant portion of the Andersons’ estate, and the sunsetting of the higher exemption amount could have profound implications for its continued viability. Robert and Sarah need to develop a comprehensive business valuation and succession plan now to minimize the total estate tax burden and ensure a smooth ownership transition to James and Emily later.
Property and Investments
Given the potential changes in the estate tax landscape, the Andersons need to revisit the valuation of their financial accounts, retirement and life insurance investments, personal property, real estate, and artwork to ensure accurate assessments. Then they need to determine which items will affect the estate tax calculation and any remaining exemption they have left from prior legacy planning. Depending on their assets’ values, these items can easily put them over the potentially soon-to-be lower estate tax exemption, exposing them to a 40 percent tax rate.
Lifetime Gifting
With the uncertainty surrounding the estate tax exemption, the Andersons may want to consider accelerated lifetime gifting strategies to reduce their taxable estate while the higher exemption is in place. The Internal Revenue Service declared in 2019 that individuals who take advantage of the increased gift tax exclusion from 2018 to 2025 will not be negatively impacted after 2025 if the exclusion amount drops.10 Gifting up to $13.61 million in 2024 has a zero tax liability. But gifting over $6.4 million in 2026 may have major consequences.
Life Insurance
The Andersons may want to use life insurance to ensure that their loved ones are provided for at their passing. They may want to consider creating an irrevocable life insurance trust to own the life insurance policy and be the recipient of the death benefit. This removes the value of the policy from the Andersons’ estate and protects the death benefit for their chosen beneficiaries.
Marital Deduction Planning
The significant portfolios of high-net-worth and ultra-high-net-worth families may require advanced tax planning techniques, including an AB trust, to optimize each spouse’s estate tax exemption and potentially minimize their estate tax liability. At the client’s death, an amount equal to the current estate tax exemption amount is placed in one trust, which uses the exemption, and the remainder is placed in a second trust for the surviving spouse’s benefit, which qualifies for the unlimited marital deduction. This results in no estate tax being owed at the death of the first spouse.
Portability and the Deceased Spouse Unused Exemption Amount
Spouses are able to give an unlimited amount of money and property to each other without having to worry about estate or gift tax. Because of this, some clients may not have an estate tax issue at the first spouse’s death because everything (or a substantial portion) went to the surviving spouse. Because they are utilizing the unlimited marital deduction, the deceased spouse’s exemption is not needed. However, even if this is the case, it may be advisable to file an estate tax return at the first spouse’s death to document how much of that deceased spouse’s exemption is being used, if any, and that the remainder is going to the surviving spouse. This will allow the surviving spouse to add the deceased spouse’s unused exclusion (DSUE) to the surviving spouse’s own exemption amount and apply that combined amount against their own estate at the time of death.
Charitable Giving
If the Andersons are philanthropically inclined, another great option would be to engage in charitable giving through the use of a charitable remainder trust. Setting up this type of trust can be time-consuming—sometimes the process is fairly straightforward but often highly complex, requiring advanced planning and consideration.
Contacting a Trusted Advisor
If your situation is similar to the Andersons, expert guidance is necessary to address estate tax issues and help you evaluate the impact of the potential sunsetting of the higher estate tax exemption amount on your estate. Contact us to learn more about strategies to protect, preserve, and pass down valuable property.
If You Own Any of These Assets, You Need to Watch Their Value
As we begin 2024, it is crucial to review estate planning goals and strategies that may be affected by changes in the federal estate tax exemption law. At the end of 2025, the Tax Cuts and Jobs Act (TCJA) the estate tax exemption, which is $10 million, adjusted for inflation, may revert to the pre-2017 exemption amount, cutting it almost in half. Depending on the types of accounts and property you own, you may need to pay close attention to their value.
You may need a complete reevaluation of your most significant investments and property to ensure that they are protected. The following items may have steadily increased in value over time, potentially creating major estate tax issues:
● Business interests
● Life insurance
● Real estate
For people with significant wealth, each of these items alone may not put you over the estate tax limits, but the combination could.
Your Business
With the uncertainty surrounding the estate tax exemption, developing a comprehensive business succession plan is crucial, especially if your goal is for the business to continue on after you have retired or passed away. Consider strategies such as gifting shares to the next generation or creating a family limited partnership.
The last thing you want to do is sell your business or farm that may have been in your family for generations (if farming is your occupation) to satisfy a looming estate tax bill. Not only would this be a financial and emotional loss, but it may also result in the loss of jobs for your family and other employees.
Your Life Insurance Policies
Life insurance policies may be an essential part of your estate plan. Review your life insurance policies to ensure that they are used effectively for your estate planning goals with the federal estate tax exemption in mind. Increasing policy values could put you over the potentially lower lifetime exemption limit.
Consider the following:
● You need to determine how much life insurance to purchase. By meeting with an experienced insurance agent and financial planner, you can ensure that you have the right amount of coverage to adequately plan for your loved ones.
● The ownership of the policy can affect estate tax liability. Transferring ownership of the policy to an irrevocable life insurance trust (ILIT) may allow you to remove the value of the policy from your estate and protect the death benefit on behalf of your chosen beneficiaries.
Multiple Real Estate Properties
Real estate can pose specific challenges in estate planning. Reassess the current value of your properties to ensure accurate tax planning, keeping the potential decrease in the estate tax exemption in mind. Depending on the economic climate, your real estate may be far more valuable than when you first acquired it. You might consider using trusts, such as qualified personal residence trusts (QPRTs), to transfer real estate to heirs while minimizing estate tax exposure. You might also consider creating an entity, or multiple entities, to own the real estate. This strategy may be able to offer additional asset protection for you and your loved ones.
Stay Informed with the Help of Professionals
The estate tax landscape is evolving, and it is important that your estate plan stays up to date. We would love to collaborate with your trusted financial and tax advisors to update your comprehensive estate plan. Your situation and family dynamics are unique, and your plan must be customized to your specific circumstances to adequately protect your property and minimize potential tax liabilities well before the estate tax exemption sunsets at the end of 2025.
1 Understanding Federal Estate and Gift Taxes, Cong. Budget Off., https://www.cbo.gov/publication/57272 (last visited Jan. 2, 2024).
2 Darien B. Jacobsen et al., The Estate Tax: Ninety Years and Counting, SOI Bull. 124, https://www.irs.gov/pub/irs-soi/ninetyestate.pdf (last visited Jan. 2, 2024).
3 Id.
4 Mark Luscombe, Historical Look at Estate and Gift Tax Rates, Wolters Kluwer (Mar. 9, 2022), https://www.wolterskluwer.com/en/expert-insights/whole-ball-of-tax-historical-estate-and-gift-tax-rates.
5 Tax Cuts and Jobs Act (TCJA), Tax Found., https://taxfoundation.org/taxedu/glossary/tax-cuts-and-jobs-act (last visited Jan. 2, 2024). 6 Understanding Federal Estate and Gift Taxes, supra note 1.
7 Id.
8 How Did the Tax Cuts and Jobs Act Change Personal Taxes?, Tax Pol’y Ctr., https://www.taxpolicycenter.org/briefing-book/how-did-tax-cuts-and-jobs-act-change-personal-taxes (last visited Jan. 2, 2024).
9 Understanding Federal Estate and Gift Taxes, supra note 1. 10 Estate and Gift Tax Facts, IRS.gov, https://www.irs.gov/newsroom/estate-and-gift-tax-faqs# (last updated Dec. 5, 2023).