As previously mentioned, the TCJA provisions are currently scheduled to expire at the end of 2025, and the inflation adjusted estate tax exemption is anticipated to land at around $6.8 million effective January 1, 2026. With such a significant change on the horizon, it may be valuable to review your estate now and start planning.
An Effective Plan
There are a combination of strategies that can be implemented in an effective estate plan, including trust structures, generational planning, charitable planning, maximizing tax advantageous accounts, and annual and lifetime gifting. The current heightened exemption limits mean that certain lifetime gifting strategies implemented before 2025 may be more effective in reducing your estate and estate tax.
Lifetime Planning Options
As previously discussed, maximizing the use of the current elevated estate tax exemption through lifetime gifting can be a key factor in reducing your estate and generation-skipping transfer tax liability. You can make gifts to beneficiaries outright or in a trust.
Using a trust is often preferred for many reasons, the most common reasons being that the assets can be protected from creditors and that you can control the ultimate disposition of those assets. Two common types of trust used for gifting are:
- Dynasty Trusts
- Spousal Lifetime Access Trusts (SLAT)
Dynasty Trusts
Dynasty trusts allow for the tax-free transfer of assets to your descendants and beneficiaries. Once you have created the trust, you would then fund assets into the trust applying your estate and generation-skipping transfer tax exemptions to those assets. Assets in the trust will remain free of estate, gift, and generation-skipping transfer tax and continue to grow tax free. The trust will define the manner in which each beneficiary receives distributions and what should happen upon a beneficiary’s death. Assets can be held in the trust for many generations.
SLAT
A married taxpayer might consider naming their spouse as the lifetime beneficiary of their Dynasty Trust. This type of trust is referred to as a SLAT.
In this strategy, the taxpayer would gift assets to a trust established for the benefit of their spouse and descendants. Their spouse can receive trust income and principal, giving the taxpayer indirect access to the trust assets for the duration of the marriage. The spouse can also serve as trustee if distributions are limited to an ascertainable standard.
Gifting Today Versus Doing Nothing
After the TCJA went into effect and the exemption doubled, there was some question around whether there would be any clawback after the sunset on gifts made using the increased exemption amount. In 2019, the IRS issued final regulations creating a rule to address this issue which is known as the Anti-Clawback Rule.
This rule clarifies that an individual or estate won’t be taxed on completed gifts that were tax free and made before 2026. Under the Anti-Clawback Rule, after the sunset, a decedent’s exemption will be the greater of what they have previously gifted or the current amount. As discussed, the estate and lifetime gift tax exemption is scheduled to revert to its previous $5 million amount – indexed for inflation – in 2026. While the exemption currently remains elevated, we’re afforded a rare estate planning opportunity.
The potential estate tax savings of utilizing the exemption now is demonstrated in the example below.
Estate Tax Savings Example
If we assume an unmarried individual’s estate is valued at $15 million, the full 2023 exemption was used to gift $12.92 million, and there’s no growth on the remaining assets, then the taxable estate in 2026 would be valued around $2.08 million.
When the elevated exemption sunsets in 2026, the potential estate tax liability would be $832,000. On the other hand, if no gifts were made, then at the sunset in 2026, the taxable estate would remain at $15 million. In that case, the potential estate tax liability would be $3.2 million.
Many states also have an estate tax, and state exemption levels are lower than the federal level, so it’s crucial to consider the state impact as well as the federal.
Next Steps
Develop a Cohesive and Comprehensive Financial Plan
Understanding your entire financial picture is crucial in order to make informed, effective decisions. Creating an effective estate plan begins with modeling your balance sheet and its growth to help predict when and if an estate will be taxable and understand how it’s currently structured.
The next step is to determine projected lifetime consumption and spending, as well as the type of legacy you want to leave for your chosen beneficiaries. This can help you decide what assets and how much can be gifted outright, in trust, or in some other manner that helps achieve your goals.
Some additional questions to consider include:
- How much liquidity will you need during your lifetime to pursue your goals and support your lifestyle?
- Do you know what your assets are worth, now or in the future?
- If you’re a business owner, do you know how much your company and stake are worth?
- What actions can be taken now that can help reduce taxes in the future, even if you don’t currently have a taxable estate?
- Are there assets that you want to avoid liquidating, and how does that change the composition of your balance sheet and estate?
- Are there people or organizations that you want to financially help during your life via charitable donations—even if the purpose goes beyond tax savings?
These questions, and many others, can be addressed during the financial planning process, and should be discussed with your financial advisor or tax professional.
Update Estate Planning Documents
Review your estate planning documents as soon as possible, and make sure they are still consistent with your goals and objectives. It’s helpful to periodically review and/ or update your estate planning documents, especially when you or your family members experience major life events. This is key in ensuring your wishes are consistently aligned with your plan.
Act Now
There are two tax years left to take advantage of current exemption limits. Proper financial and estate planning today can help save you unnecessary taxes in the future, and because the planning process can be lengthy, it is important to begin as soon as possible.
We’re Here to Help
If you have questions about how to navigate changes to estate and gift tax exemptions, reach out to your Moss Adams professional for more information.
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