Understanding the Federal Estate Tax
The federal estate tax, oftentimes referred to as the “death tax,” applies to the transfer of the deceased’s assets, including cash, real estate, stocks, and other assets. The tax is calculated on the current fair market value of these assets, not their original purchase price. The Tax Cuts and Jobs Act (TCJA), which was enacted in 2017, effectively doubled the exemption amount for estate taxes from $5 million to $10 million. The higher exemption amount is also indexed for inflation, meaning we have seen a consistent increase in exemption thresholds since 2017.
For 2024, estates valued below $13.61 million are exempt from the federal estate tax, a relief for most American families. This adjustment allows married couples to collectively shield up to $27.22 million from these taxes. If your assets exceed the adjusted exemption amount, immediate planning is essential to mitigate tax liabilities. Americans whose total assets are lower than the current exemption level should still explore proactive estate tax planning due to the looming “sunset” built into the TCJA which will result in the exemption threshold being slashed in half. Based on the 40% tax rate applied to the difference between the current and projected exemption amounts, individuals will lose approximately $2.644 million in tax-exempt transfers in 2026.
Planning Strategies
If you believe the looming sunset will affect your estate, your first step should always be to seek out an experienced estate planning attorney that can provide an overview of the planning options available to you given your unique financial and familial circumstances. Below are a few options that may be helpful for you and your family to employ before the sunset.
- Lifetime Giving
The annual gift tax exclusion also increased in 2024 to $18,000 per person. This increase means that you and your spouse can each gift up to $18,000 each year to as many individuals as you want. Employing this gift strategy with children, grandchildren, and even friends can greatly reduce your total estate without incurring any immediate tax concerns for you or the recipients. This option allows you to provide immediate and tangible benefits to your loved ones and, when employed over a number of years, can significantly reduce the potential tax burden of a large estate.
- Charitable Giving
For those with philanthropic goals, preparing gifts to qualified charities can help reduce the overall liability for estates over the death tax threshold. Gifts to qualifying charities are deductible from your gross estate and are a powerful tool to implement in your estate plan.
With the help of an experienced attorney, you may also stand to benefit from the formation of a charitable remainder trust, which can be designed to effectively reduce your overall taxable estate while also providing a stream of income.
- Spousal Transfers
Spouses can transfer an unlimited amount to one another upon the death of the first of them. Whether you and your spouse consider all assets community property or have different plans for your separate property, a properly tailored estate plan can help take advantage of the unlimited exclusion to ensure your family can take advantage of both spouses’ death tax exclusion.
- Irrevocable Trusts
For Americans that expect to live past the 2026 sunset, gifting assets into irrevocable trusts may assist with lowering their total estate value while also taking advantage of the pre-sunset lifetime gift tax exclusion threshold.
One common option for married couples calls for the creation of a Spousal Lifetime Access Trust (SLAT). SLATs are funded with gifted assets from one spouse and controlled by the other spouse and can be designed to pass down to children or other beneficiaries in a way that is consistent with your overall estate planning goals.
Additional types of irrevocable trusts are available for use depending on the type of assets in an individual’s estate. For example, if you have an asset you expect to increase in value over time, you might take advantage of an Intentionally Defective Grantor Trust (IDGT). Individuals can gift or sell assets to an IDGT in exchange for a promissory note and establish the ultimate beneficiaries of the new trust. While the individual would continue paying the income tax for the trust during their lifetime, the increasingly valuable asset gifted or sold to it will not be treated as part of his or her estate.
SLATs and IDGTs are only two examples of a myriad of irrevocable trust options that, with the guidance of an experienced attorney, can greatly complement an individual or family’s estate plan.
- Relocation
Thirteen states and the District of Columbia impose their own estate taxes, often with lower exemption thresholds than the federal estate tax. You should check your own state’s laws to see if you are currently living in a jurisdiction that imposes its own estate tax. Many Americans choose to relocate to a state like Arizona that does not impose an additional estate tax on its deceased residents.
Conclusion
The looming death tax sunset built into the current federal law is set to impose estate taxes on a major portion of Americans that may not currently be concerned about their exposure. Without proper, proactive planning in place leading up to 2026, you may well miss out on the opportunity to transfer several millions of dollars’ worth of your hard-earned estate to your chosen beneficiaries. Set a free initial consultation with Soto Law Firm today to start planning to preserve your legacy today.
