Today’s Tax Savings Opportunities May Not Be Available Tomorrow
Estate planning is about more than reducing taxes; it’s about ensuring your loved ones are taken care of after you’re gone and that your assets are distributed according to your wishes. However, the Tax Cuts and Jobs Act (TCJA) has temporarily increased the estate, gift, and generation-skipping transfer (GST) tax exemptions to record-high levels. While fewer taxpayers are currently concerned about these taxes, the increased exemptions are set to expire after 2025. Therefore, now may be the time to take advantage of these opportunities before they disappear.
Estate Tax
The TCJA doubled the estate tax exemption amount from $5 million to $10 million, which is annually adjusted for inflation. However, this increased exemption is set to expire after 2025, meaning the estate tax exemption will revert to $5 million (inflation-adjusted) in 2026.
If your estate is worth between $7 million and $14 million (or double that for married couples), your estate may escape estate taxes under the current exemptions, but could be subject to taxes after 2025. To ensure that your estate planning is up-to-date, consider reviewing your estate plan to make the most of the current exemptions.
Gift Tax
The gift tax exemption is also temporarily increased under the TCJA, and any exemption used during your lifetime reduces the estate tax exemption available at death. If your estate might exceed $7 million (or double that for married couples), it may be smart to use some of your lifetime exemption now.
Under the annual gift tax exclusion, gifts up to a certain amount can be made without using any of your gift or estate tax exemption. The annual exclusion doesn’t carry over from year to year, so any unused exclusion from the previous year cannot be added to this year’s exclusion.
GST Tax
The GST tax applies to transfers to individuals two or more generations below you, like grandchildren. The GST tax exemption also temporarily increased under the TCJA. If you have a large estate, you can use the GST tax exemption to transfer wealth to your grandchildren without incurring taxes at your children’s generation.
State Taxes
While the TCJA impacts federal estate taxes, some states impose estate taxes at lower thresholds than the federal government. As a result, your state’s tax laws should be a key consideration in your estate planning. Be sure to consult a tax advisor to understand your state’s specific laws.
Exemption Portability
If one spouse dies and leaves unused estate tax exemption, the surviving spouse can use it through exemption portability. This provides flexibility if the first spouse’s exemption isn’t fully utilized. However, portability has limits—it doesn’t apply to the GST tax exemption and may not be recognized in some states. It must also be elected on an estate tax return for the deceased spouse.
Tax-Smart Giving
Gifting assets now can reduce your taxable estate. Here are some strategies for tax-smart giving:
Choose Gifts Wisely:
Gift property with high future appreciation potential to reduce estate taxes.
Gift property that hasn’t appreciated significantly to minimize income tax for the beneficiary.
Don’t gift property that’s declined in value; instead, consider selling it and gifting the proceeds.
Plan Gifts to Grandchildren Carefully:
Annual exclusion gifts help preserve your GST tax exemption, and gifts to grandchildren can be tax-efficient if structured correctly.
Gift Interests in Your Business or Family Limited Partnership (FLP):
Business ownership interests can be gifted with valuation discounts, which reduce the taxable value for gift tax purposes. However, these gifts may be scrutinized by the IRS, so proper setup is essential.
Pay Tuition and Medical Expenses:
Tuition and medical expenses paid directly to the provider are exempt from gift tax.
Make Gifts to Charity:
Donations to qualified charities are not subject to gift tax and may provide income tax deductions.
Consider “Taxable” Gifts:
Making gifts beyond the annual exclusion and using lifetime exemptions can protect future appreciation from your estate. However, the recipient’s income tax must be considered, as gifted assets do not receive the “step-up” in basis.
Trusts
Trusts can provide substantial tax benefits while preserving control over assets. Some trusts to consider include:
Credit Shelter Trust: A trust that allows the first spouse to take advantage of their estate tax exemption. It benefits the children, with the surviving spouse potentially receiving income.
QDOT (Qualified Domestic Trust): This trust allows non-U.S.-citizen spouses to take advantage of the unlimited marital deduction.
QTIP Trust (Qualified Terminable Interest Property Trust): Provides income to the surviving spouse while giving control of the property’s final disposition to the deceased spouse.
ILIT (Irrevocable Life Insurance Trust): Keeps life insurance proceeds out of your estate, preventing them from being subject to estate tax.
Crummey Trust: Enables gifts to be made while maintaining control over the timing of asset transfers.
GRAT and GRUT (Grantor-Retained Annuity Trust/Grantor-Retained Unitrust): Allow you to transfer assets to your children while receiving payments during the trust’s term, reducing the taxable value for gift tax purposes.
QPRT (Qualified Personal Residence Trust): Allows you to transfer a home to beneficiaries while retaining the right to live in it for a certain period.
Dynasty Trust: A long-term trust that allows wealth to pass through generations without being taxed at each generation, potentially locking in today’s high exemption amounts.
Life Insurance
Life insurance can be an essential tool for estate planning, replacing income, equalizing assets among children, or providing liquidity to pay estate taxes. However, if you own the policy, its proceeds will be included in your estate. To avoid this, consider transferring ownership of the policy to a trust (such as an ILIT), which can keep the policy proceeds out of your estate.
Choosing the correct ownership structure for your life insurance policy is crucial. Consider the reasons for the insurance (income replacement, estate liquidity, or wealth transfer) and the tax implications before making a decision.