For individuals and families with significant wealth, the estate tax is often a critical consideration, as it can significantly reduce the inheritance passed on to beneficiaries. Fortunately, federal law provides an exemption to shield a portion of an estate from taxation. However, recent changes to this exemption, especially following the Tax Cuts and Jobs Act (TCJA) of 2017, have created uncertainty about its future.
Changes to the Estate Tax Exemption
Under the TCJA, the estate tax exemption was significantly increased. However, this increase is temporary, and the exemption is scheduled to revert to its previous level after 2025 unless new legislation is passed. Here’s a brief overview of the changes:
– Pre-TCJA Exemption: Prior to the TCJA, the estate tax exemption was set at $5.49 million per individual in 2017.
– Post-TCJA Exemption: The TCJA increased the exemption to $11.18 million per person starting in 2018. This amount is adjusted for inflation annually, and for 2024, it is set at $13.61 million.
– Reversion to Pre-TCJA Levels: The increase in the exemption is scheduled to expire at the end of 2025. Without new legislation, the exemption will revert to an estimated $7 million per person starting in 2026.
This potential reduction means that individuals with estates exceeding the exemption threshold could face higher estate taxes in the future, which makes it crucial to consider strategies to protect wealth before the exemption level changes.
Strategies for Minimizing Estate Taxes
To mitigate the impact of the impending reduction in the estate tax exemption, individuals with estates that could exceed the new limits in 2026 should consider transferring assets or taking steps to reduce the taxable value of their estates. Several strategies are available for this purpose:
1. Lifetime Gifts
One of the most common ways to reduce the size of an estate is through lifetime gifting. The IRS allows individuals to give assets to others without incurring gift taxes, up to certain limits. In 2024, the annual exclusion is $18,000 per recipient. The estate tax exemption applies to lifetime gifts as well, meaning individuals can reduce their estate by gifting assets while the exemption level remains high.
– Strategy: Consider gifting assets to heirs before the exemption decreases in 2025, utilizing the full exemption amount to transfer wealth while minimizing future estate taxes.
2. Irrevocable Trusts
Transferring assets into an irrevocable trust can effectively remove those assets from the taxable estate. Irrevocable trusts come in various forms, such as Grantor Retained Annuity Trusts (GRATs) and Irrevocable Life Insurance Trusts (ILITs). These trusts allow individuals to transfer wealth to beneficiaries while retaining control over how assets are used.
– Strategy: Use irrevocable trusts to transfer assets that will no longer be subject to estate taxes, ensuring that beneficiaries receive wealth according to your wishes.
3. Spousal Lifetime Access Trusts (SLATs)
A SLAT is an estate planning tool that allows an individual to transfer assets to a trust for the benefit of their spouse and future generations. By transferring assets up to the current exemption level, individuals can protect these assets from estate taxes. The couple can use the trust during their lifetimes, and upon death, any remaining assets can be passed on to other beneficiaries.
– Strategy: Establish a SLAT to provide financial support to your spouse while also safeguarding assets from estate taxes for future generations.
4. Charitable Giving
Charitable donations are another strategy to reduce the taxable estate. Contributions to charitable causes, whether through direct gifts or charitable trusts, can lower the estate’s value while providing tax benefits.
– Strategy: Consider making charitable donations to reduce the size of your taxable estate, and explore charitable trust options to maximize both charitable impact and tax savings.
5. Family Limited Partnerships (FLPs) and Family Limited Liability Companies (FLLCs)
For business owners, FLPs and FLLCs offer an effective method of transferring business ownership to family members while maintaining control. By structuring the business ownership with family members, business owners can transfer shares at discounted values for gift and estate tax purposes.
– Strategy: Utilize FLPs or FLLCs to transfer business ownership to heirs gradually, while minimizing the gift and estate tax impact and ensuring continued control over the business.
Conclusion
The potential reduction in the estate tax exemption in 2025 presents a critical opportunity for high-net-worth individuals to take proactive steps in estate planning. Whether through gifting, trusts, charitable donations, or family business strategies, there are multiple ways to minimize the impact of estate taxes and protect wealth for future generations. Working with an experienced estate planning professional can ensure that you make the most of the current exemption before changes take effect.
