This January, the federal estate and gift tax exemption increased to nearly $14 million per person, or $28 million for a couple.
The exemption is the amount of assets that can be shielded from federal estate taxes, either through lifetime gifting or at death.
Unless Congress acts, however, current tax law will “sunset” on January 1, 2026, reverting the exemption amount to its inflation-adjusted 2017 level—roughly half of what it is currently. Estates valued at more than the exemption amount are currently taxed at federal rates as high as 40%.
Why This Matters
The sunset provision means an individual who passes away in 2026 may only be able to pass on $7 million free from federal estate tax, versus today’s $14 million, before facing stiff federal estate taxes.
Consider Joan, whose current estate is valued at $15 million. She wants to give $10 million to her children. Under current law, Joan can use the $13.6 million exemption to make a $10 million tax-free gift. If she delays gifting until 2026, and current law sunsets, just $7 million would be considered tax free. That means $3 million of Joan’s gift would be subject to a 40% gift tax—a tax payment of $1.2 million.
Do I Need to Act?
Folks anticipating gifting more than the post-sunset exemption amount—again, nearly $7 million for an individual and $14 million for couples—are the ones who should consider acting now.
Those with taxable estates less than the post-sunset exemption amount and those who don’t intend to make large irrevocable gifts needn’t worry.
That said, it is important to account for any expected appreciation in your estate. Years of future compounding might make your current estate more valuable, to the level it exceeds future federal estate and gift exemption amounts.
Consider a couple with a $12 million estate today. Under current law and the expected exemption reduction in 2026, they could the pass the entire amount to heirs free from federal estate tax. But assuming 8% annual growth, their estate would grow above the exemption amount in 2026 and they would likely face an estate tax bill.
Keep it Simple
There are a number of strategies folks with federally taxable estates might consider to alleviate their expected future tax burden.
Far and away the simplest strategy is to fully utilize the annual gift exclusion of $18,000 per person. This allows any person to immediately give away, to an unlimited number of individuals, up to $18,000 per year without eating into their lifetime gift exemption.
Married couples can give up to $36,000 to an individual each year, meaning parents of three grown children could give away a total of $108,000 each year without reducing their lifetime exemption. They could double that amount by gifting to their kids’ significant others, too.
Direct payments for medical bills or tuition payments do not count against this annual exemption amount, so can be extra ways to support family and friends while reducing one’s taxable estate.
Other Strategies to Consider
A few more complex estate planning techniques, which should be considered and drafted carefully with the help of a qualified estate professional, include:
Irrevocable Gift Trust: While these trusts are completed gifts for federal tax purposes, grantors can retain some control over when a beneficiary accesses the trust. Gifting via an irrevocable trust can provide significant tax advantages over estate bequests, while also protecting trust assets against a beneficiary’s ex-spouse or financial creditors.
Spousal Lifetime Access Trust: An irrevocable trust established by one spouse for the benefit of the other spouse. Couples can then spend trust assets, while removing the funded amount from the first spouse’s taxable estate. This effectively “locks in” today’s higher federal exemption.
Qualified Personal Residence Trust: This trust allows an individual to remove a personal home or vacation property from their estate to reduce the tax otherwise incurred when transferring the home(s) to a beneficiary years down the road.
Grantor Retained Annuity Trust: This is a type of irrevocable trust created for a certain period of time, during which an annual stream of income is paid back to the grantor. At trust expiration, assets are transferred to the beneficiaries with little or no gift tax.
Keep in mind, these trusts must be carefully considered and should be drafted with the help of a qualified estate professional to avoid inadvertent inclusion in an estate for tax purposes.
Final Thoughts
The upcoming federal estate exemption sunset may provide certain individuals and families with a timely tax saving strategy. Even if the sunset doesn’t apply to you, the approaching deadline serves as a good reminder to review or create one’s estate plan.
It is important to remember that gifting is an irrevocable decision that results in a loss of control of assets. Gifting too aggressively could leave you with too little for your own lifetime needs.
As always, the effectiveness of any estate plan will depend on an individual’s unique circumstances, planning goals, and income needs.
Reach out to your advisors at Vista if you have questions. We’re here to help.