Give It Away, Give It Away, Give It Away Now?
The Sunset of the Enhanced Estate Tax Exemption is Approaching
The lifetime estate and gift tax exemption is currently at an all-time high, but it’s set to undergo a significant reduction in the not-so-distant future. The Tax Cuts and Jobs Act, enacted in 2017, doubled the federal estate tax exemption from $5 million to $10 million (adjusted for inflation). As of 2023, each individual can claim a federal estate tax exemption of $12.92 million, allowing a married couple to transfer nearly $26 million without incurring any federal estate tax. This is important because the portion of an estate that exceeds the exemption is taxed at the hefty rate of 40%. However, unless Congress acts by the end of 2025, this exemption will shrink to an estimated $7 million per individual due to a “sunset” provision in the Tax Cuts and Jobs Act.
How can families with assets over the previously mentioned $26 million prepare for this impending shift?
1. Define Your Wealth-Transfer Vision
If you anticipate potentially facing estate taxes when the law changes, it’s essential to determine how much of your wealth you’d like to pass on to your family. Most estate plans may have three potential beneficiaries: your family and loved ones (typically the most common), charitable organizations, and, of course, the federal government.
Most individuals prefer not to allow a substantial portion of their wealth go to the government, so they find a way to mitigate their estate tax liability—we like to call this “disinheriting the federal government.” Some may choose to leave a modest portion of their estate to their children and allocate the rest to their favorite charitable causes. Bottom line: it’s crucial to align your plan with your values and priorities. Estate plans do not fall into the ‘one size fits all’ category!
2. Utilize Lifetime Gifting Strategies
If the amount of wealth you intend to leave to your family exceeds (or is projected to exceed) the future federal exemption limit, you still have time to implement proactive gifting strategies. Remember that the historically high estate-tax exemption remains in effect until the end of 2025, currently leaving you more than 24 months to plan and act.
To take advantage of this exemption, you may gift a significant portion of your assets to your family. However, be mindful that substantial gifting decisions should not be made lightly. Often, gifting is an irrevocable decision that entails relinquishing control over the assets and forfeiting certain tax benefits, such as a step-up in cost basis at death.
One potential strategy is the use of a spousal lifetime access trust (SLAT), allowing each spouse to establish an irrevocable trust for the benefit of the other while removing the gifted assets from their taxable estate. This can secure the higher exemption before it halves in 2026. Nevertheless, it’s essential to consult an estate planning professional to carefully design the trust and address potential drawbacks.
If substantial gifting doesn’t align with your current plans or comfort level, you can still manage your future estate-tax liability by making gifts over time using various strategies, including qualified personal residence trusts (QPRT), irrevocable life insurance trusts (ILIT), grantor retained annuity trusts (GRAT), family limited partnerships (FLP), and split-interest charitable trusts like charitable lead annuity trusts (CLAT) and charitable remainder trusts (CRUT).
Additionally, for more modest gifts, you can leverage the annual gift tax exclusion, allowing each individual to gift up to $17,000 per recipient in 2023. Gifts exceeding this amount will require filing a gift-tax return, with any excess counting against your estate-tax exemption at death. Direct payments to healthcare providers or educational institutions can also be made without affecting the lifetime exemption amount.
3. Remember State-Based Estate Taxes
While the federal estate tax garners significant attention, it’s essential to be aware of state-based estate taxes. Currently, 12 states (Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington) and the District of Columbia have an estate tax with much lower exemptions than the federal level. Some states (Iowa, Kentucky, Nebraska, New Jersey, Pennsylvania, and, again, Maryland) also impose inheritance taxes. Depending on your location, you may want to plan carefully to minimize the impact of state estate taxes, including the possibility of relocating to states with lower or zero estate taxes.
4. Don’t Forget About the Fundamentals
Amid the focus on taxes, it’s vital not to neglect the fundamentals of estate planning. Review your estate plan documents regularly, as changes in laws or personal and financial circumstances can render them outdated. Ensure that beneficiary designations on life insurance policies and retirement accounts are aligned with your intentions. Also, check the titling of assets to avoid unexpected tax and administrative complications, such as probate. Periodic reviews and updates to your estate plan, especially following significant life events, such as births, deaths, changes in residence, or liquidity events, are crucial for a sound and effective plan.
Planning ahead is always the best approach, especially as the sunset provisions in the 2017 Tax Cuts and Jobs Act draw near. Consult with your financial and legal professionals to make well-informed decisions regarding your estate and wealth transfer strategies.
For informational and educational purposes only. Not intended as legal, tax or investment advice or a recommendation of any particular security or strategy. The views and opinions expressed herein, specifically expressions of “I”, “my”, “we” or “we feel”, are those of the author(s) and do not necessarily reflect the views of Constellation Wealth Advisors, Quadrant Capital Group LLC, or its affiliates, or its other employees. Past performance is not indicative of future results. Constellation Wealth Advisors, LLC (“Constellation”) is a registered investment adviser. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice. For more information about Constellation Wealth Advisors, including the firm’s Form ADV Part 2A Brochure, please visit https://adviserinfo.sec.gov or contact us at 513.871.5500.