by: Jeff M. Brandon, Senior Wealth Planner
Since the passage of the 2017 Tax Cuts and Jobs Act (TCJA), estate tax exemptions have reached historic highs. The legislation doubled the lifetime estate tax exemption, allowing wealthy individuals to pass down significantly greater levels of wealth, free from estate taxes.
But unless Congress passes new legislation, this provision is scheduled to sunset on January 1, 2026 at which time the estate tax exemption will revert to the previous level, adjusted for inflation – around half the current thresholds. Needless to say, this pending sunset promises to have significant estate planning implications for wealthy individuals and their families.
To preserve wealth as effectively as possible, it’s important for individuals to proactively consider their estate planning strategy. Individuals still have plenty of time to leverage gifting strategies, set up trusts, or pursue other estate planning strategies that maximize the opportunities afforded by the current elevated lifetime exemption.
In this overview, we outline the current state of the pending sunset of the estate tax exemption threshold and share several estate planning and tax strategies that individuals can employ to optimize their estate taxes.
At the time of passage, the TCJA raised the lifetime exemption to $11.2 million for individuals, double the previous exemption of $5.6 million. The exemption is indexed to inflation, and today sits at $13.61 million for individuals; double that for married couples. The first $1 million of assets in an individual’s estate above this threshold are taxed on a graduated scale from 18% up to 40%, with further assets taxed at a flat rate of 40%.
If the provision sunsets on January 1, 2026, the lifetime estate tax exemption will be lowered to previous levels, adjusted for inflation, meaning it will be roughly half of what it is today. This may have significant tax implications for individuals whose estates contain assets exceeding these thresholds.
There does seem to be some appetite from both parties in Congress to address this issue. Many experts believe the most likely scenario is that the estate tax exemption will be lowered to somewhere between current and previous levels.
What will happen remains to be seen. Any decision to adjust the lifetime exemption before 2026 will likely be driven by wider financial, economic, and political considerations. Regardless of where the lifetime exemption ultimately lands, there are steps that individuals can take today to minimize their estate’s tax burden.
A key driving factor of an individual’s estate planning strategy is the financial legacy they aim to leave behind. To a certain extent, paying estate taxes is optional. Individuals can instead choose to distribute assets in their estate above the lifetime exemption to charities.
Alternatively, individuals may leverage a variety of sophisticated estate planning strategies that transfer assets out of their estate in a tax-efficient manner. What follows is an introduction to several strategies that are particularly relevant given the pending sunset of the estate tax exemption.
Over the coming weeks, the Smith + Howard Wealth Management team will explore each of these strategies in a series of articles. To receive an alert when these articles are published, sign up for our newsletter.
For those that can afford to do so, gifting assets from your estate throughout their life can result in significant tax advantages. Treasury Decision 9884 in November 2018 confirmed that gifts made from 2018 – 2025 will not be subjected to retroactive estate taxes when the current estate tax exemption sunsets. This makes the next two years an opportune time for individuals to gift assets out of their estate.
Gifts under $18,000, or $36,000 for married couples, do not count toward the lifetime exemption. These limits are set on an annual basis, per benefactor, meaning that a married couple could give up to $36,000 to as many individuals as they like on an annual basis without being subject to gift taxes or eating up a portion of their estate tax exemption. For more on gift taxes, see our previous article here: An Overview of Key Tax and Non-Tax Issues in Estate Planning
When investing in a 529 Education Plan, individuals are permitted to use five years of their annual gifting allowance per benefactor at once. Individuals may invest $90,000 and married couples may invest $180,000. This allows wealthy families to superfund education plans for their children or grandchildren that can be used to pay for private school education and post-secondary education. To avoid inclusion in the grandparent’s estate, the parents of the child receiving the benefit should be specified as the owners of these plans.
Other actions do not count toward annual and lifetime gifting limits, namely directly paying tuition payments or medical expenses on behalf of other individuals. By leveraging the gifting strategies outlined here, many individuals can move significant portions of their wealth out of their estate without triggering any tax reporting requirements.
Irrevocable Life Insurance Trusts (ILITs) are poised to rebound in popularity. These trusts own and control life insurance policies on the behalf of the estate’s benefactors. Upon the individual or the second spouse’s death, the benefits stemming from the life insurance policy are protected from estate taxes.
An ILIT can be established to own either an individual or a second-to-die life insurance policy that only pays out once both spouses have passed. It’s vital to ensure that an ILIT is set up correctly in order to deliver life insurance benefits outside of the insured’s estate.
A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust that enables individuals to pass appreciation of assets during the term of the trust, either using none or an insignificant amount of their lifetime estate tax exemption.
GRATs provide grantors with an annual income stream in the form of an annuity payment calculated using the IRS Section 7520 rate. When the GRAT expires, the beneficiaries of the trust receive the appreciation above the 7250 rate.
Intentionally Defective Grantor Trusts (IDGTs) are an estate planning strategy used to freeze certain assets within an individual’s estate via a sale for estate tax purposes.
The beneficiary receives income from the trust during their lifetime, but the grantor pays the income tax on this income. When the grantor dies, the assets within the trust are not subject to estate taxes, passing to the trust beneficiaries tax-free.
Spousal Lifetime Access Trusts, or SLATs, are irrevocable trusts that one spouse creates for the benefit of the other. A correctly-structured SLAT removes assets from an estate while providing the grantor indirect access to the assets contained in the trust.
This allows wealthy individuals to leverage the current high estate tax exemption when transferring assets out of their estate. Today, an individual would be able to transfer their full lifetime exemption of $13.61 million into a SLAT, but in 2026, this would be halved to the lower estate tax exemption. Taking the step to fund a SLAT before 2026 can result in significant estate tax benefits.
Though we are under two years away from the pending sunset of the current estate tax exemptions, the time to act is now. Current legislation affords wealthy individuals a wide range of tax saving opportunities that allow them to pass a greater portion of their wealth to their heirs free of estate taxes.
Taking a proactive approach, guided by qualified financial planning professionals, is always the optimal route. At Smith + Howard Wealth Management, our team works hand-in-hand with experienced tax advisors and estate attorneys to develop estate planning strategies with the goal of helping our clients build a lasting financial legacy.
To learn more about our services, contact a Smith + Howard Wealth Management professional today.
Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.
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