Great news! The Federal estate tax exemption got bumped up again. Yay!
The Federal Estate Tax exemption … you know, the tax they hit you with when you die if you’ve been successful? The 40% tax above a certain level? That tax.
At Wealth Legacy Group®, our Critical Actions Roadmap™ ask clients the estate planning questions that their attorney should … but usually doesn’t.
Several times a year, I am given the sobering responsibility of conversation with someone who is soon to join the “Choir Invisible” (Thank you, George Elliot.) Someone who has put off estate planning until “later.” Now, the medical results have moved the “someday I’ll get around to it” to “I’ve run out of time.” It’s a hard conversation, but one that clarifies what is truly important.
“I can only imagine, R. J., but why are we talking about this now?”
The substantial estate tax exemption increase from the Tax Cuts and Jobs Act (TCJA) of 2017 “sunsets” at the end of 2025. The TCJA significantly increases how much you can move out of your estate and escape taxation. Coupled with expert trust planning, this wealth can escape estate taxes forever!
If you don’t move that money out before the sunset of TCJA, you’re stuck back at the lower exemption amounts, and that means more of your hard-earned money gets sent off in taxes rather than where you want it to go.
We pay taxes, and someday we will meet our Maker. But fortunately, through thoughtful, advanced planning, there are strategies to make death taxes OPTIONAL …“Imagine That™!”
What's an Estate Tax?
First things first. What is an “estate tax?” Who do we owe it to? And why?
It is a tax on our right to pass along assets from ourselves to someone else, usually our loved ones. (Although sometimes it goes to our beloved four-legged friends, see Gunther’s Millions on Netflix.)
It’s often referred to as the “death tax.” (Technically, there are a few types of death taxes, this one is from the estate.)
There are also inheritance taxes in some states too … and we’ll cover the poor residents of Maryland in a moment.
The most common reasons given for the estate tax (either Federal or State) is to give money to the taxing authority to help others less fortunate through programs from the Fed/State, and to redistribute wealth as a step to address wealth disparity. (Or so they say.)
Why so Urgent?
The Federal estate tax exemption isn’t just something that goes into effect when you die. (It’s hard to pin that on the calendar.) You can plan for it ahead of time.
We don’t have a crystal ball on how Congress is going to handle the sunset of TCJA at the end of 2025. But if we plan for the sunset, it’s a win-or-break-even scenario. If you don’t plan, it’s a break-even-or-lose. Personally, I expect that Congress will allow TCJA to expire and, therefore, the Federal estate tax exemption to be dramatically reduced come 12/31/2025.
The expected end of TCJA will be here in a nano-second. So what can we do to capture an advanced planning strategy while we still can?
Let’s look at an example.
Meet the Millers. Their estate is worth $25 million. If they act now with advanced planning strategies, they won’t owe the IRS a cent. If they wait until “later,” they might owe 40% in estate taxes on roughly $12 million of their estate … in other words, $4,800,000 in needless taxes simply because they didn’t take advantage of the special exemptions we have available today.
The State of the Estate Tax Exemption
With the Tax Cut and Jobs Act of 2017, the estate tax exemption got a huge bump. And, we’ve seen some rather substantial increases every year since. (One of the few good things from having a 9%+ inflation rate this last year!)
Now, in 2023, the Federal estate tax exemption is $12.92 million, up from $12.06 million in 2022. For married couples, that math works out to an exemption of $25.84 million.
But above that? Whooo-eeee. You’re looking at a 40% tax on assets. And that 40% is due nine months after the date of death … and IRS only takes cash or a cashier’s check for payment of the tax! Ouch … (They don’t even send a thank you note or anything, but that’s another issue.)
But it is all manageable and avoidable. We show our clients how to make estate taxes optional. Through proper planning in advance, we can prevent the IRS from sending your executor tax bills like they’re shooting them out of a confetti machine.
The biggest concern for most people is realizing the Tax Cuts and Jobs Act sunsets on 12/31/2025. This means that the Federal estate tax exemption returns to the $5 million per person credit PLUS an inflationary factor. Most of us are guessing that after factoring in inflation, the new exemption will be somewhere in the $6 – $7 million per person range. A far cry from the nearly $13 million per person today …
So What Can I Do About It?
Thankfully, the IRS gives us several workarounds, some of which exist because they want to encourage community-minded behavior. In other cases, perhaps because not enough people know about them to make it worth the time and energy to nullify the strategies.
It’s beyond the scope of this article dive into the weeds of each of these strategies. But if you want some light reading, start with the following techniques to reduce the amount of assets or get them out of your estate entirely. (You’re also welcome to call us!)
Spousal Lifetime Access Trusts (SLATs)
As mentioned above, this is a fun one. It’s basically a compression sleeve for your assets.
You are allowed to “squish” down the value of your assets. For example, if you have a $37 million estate, you can squash it down to roughly $26 million in IRS-recognized value.
First, you’ll create a SLAT for each spouse. Usually, the IRS will allow a 30% reduction in value without too much heartburn. Right out of the gate, we’re reducing the amount of assets subject to estate tax.
Do note that the SLATs cannot be identical to one another. (Creating “reciprocal trusts” is a no-no!) A spouse can be trustee for their better half’s SLAT, so there is still accessibility to the income. But there have to be some meaningful differences in certain key aspects. For example, one spouse might have co-trustees or name their one of their adult children as a trustee. You can also vary factors in terms of assets, terms, trustees, beneficiaries, and even creation dates.
In short, if a husband and wife have less than $37 million in assets, we can compress that down (all IRS-sanctioned) into about $26 million to squeeze them under the Federal estate tax benchmark. But … this has to be all finished before December 31, 2025!
Split Interest Gifts
I love the blend of providing income for your family while also looking out for folks and/or causes in need of some financial assistance. Plus, the tax benefits aren’t shabby, either.
There are a few ways to do this.
You could create a private pooled income fund or “Private PIF.” A creation of the Tax Reform Act of 1969, in 2017, this idea got a new coat of paint and can now be created for an individual or single family instead of for a “pool” of investors.
Typically, the grantor will gift assets to the trust. The assets can now be sold for zero in capital gains taxes, by the way. The grantor gets an income stream for the rest of your life based on the income from the assets in the PIF. Then, after all the beneficiaries kick the bucket, whatever is left in the PIF bucket will go to the charity(ies) you named. Recognize this could be a hundred years worth of income, and up to four generations.
Oh, and you also get a charitable deduction for the year you transfer the assets. Boom!
Recently I met with a university planned giving officer who has a family who wants to give money back to the university. It’s a mother and daughter in their 90s and 70s, respectively.
Using the PIF, they could put one million dollars (that’s the minimum) into a special type of trust. The trust will pay the mother and the daughter an income for the rest of their lives. After both are gone, whatever is remaining inside the bucket goes to the university.
Despite receiving (very likely) several million dollars of income over both lives, the mother receives a income tax deduction of $738,910 per million put into the special trust. In a nutshell, it’s a charitable tax deduction today based on the present value of the future gift.
The charitable remainder trust is another good strategy.
You fund the trust. The assets grow and make payments to you for either a specific term of up to 20 years or lifetime(s)! You will pay tax on the income stream, that’s it. Then when all is said and done at the end of the time frame, everything left in the trust goes to the charity(ies) that you named when creating the trust. And, we build in the ability to change the charitable beneficiary during the trust creator’s lifetime.
You get an income stream for life, fund charities you love, avoid the death taxes, and get a massive income tax deduction. Can it get any better than that?
Donor-Advised Funds & Private Foundations
I like calling donor-advised funds “Family Giving Funds” because they are so personal and reflect the values of those setting them up. My darling wife and I use this one ourselves.
Here’s how it works. You donate cash, assets, equities, and the like to the fund and get a deduction for that donation as if you were giving directly to a charity. The donations grow tax-free. (Yay!) You make “grant recommendations” to the IRS-qualified charity(ies) of your choice.
You could also set your own private foundation. This is far more expensive and is now tightly regulated by the government because of abuses in the past. It’s beyond the scope of this article to compare private foundations and donor-advised funds, but it is an attractive options for families of significant wealth.
Either way, using a Family Giving Fund or private foundation is great practice for your heirs to work together on decision-making so your wealth beats the odds of vanishing within two generations.
In addition, gifts to your Family Giving Fund or Private Foundation are not subject to estate tax. Some people even include language in their trusts to donate assets to the family foundation or other charity(ies) if those assets are subject to estate taxes.
Irrevocable Life Insurance Trust
Life insurance is a wonderful asset. It is not subject to income tax or capital gains taxes in most cases. However, if you own your life insurance, your life insurance face amount will be included in your estate when you die … and what’s the point of non-taxable life insurance benefits if they’re just going to be hit with the estate tax?
As long as the total value of assets is below the estate tax exemption, then no harm no foul. But if you are above or nearly above the estate tax exemption, you should consider moving the ownership of your life insurance outside of your estate.
How do you do that?
You create an irrevocable life insurance trust (ILIT) to own the insurance. It’s better to use new insurance, as existing insurance can still be included in your estate if this is not done properly. It can either be term or permanent insurance. It can also be a traditional life insurance policy or a second-to-die contract.
Once again, it’s beyond the scope of this article, but we can create a partnership to own the life insurance rather than an irrevocable trust.
As with everything, the devil is in the details. Still, removing the death benefit from your estate can be another way to reduce or eliminate your estate taxes, federally or for the state.
Other Life Insurance Strategies
What if you can’t avoid the estate tax because you have been too successful?
Well, then the next step is to find a way to pay for the estate tax as inexpensively as possible. That’s why wealthy families typically buy large amounts of life insurance owned in a special trust (see above.)
The life insurance can itself be arranged in such a manner that there’s no tax on the insurance proceeds, but the funds can be used to give liquidity to the estate by buying assets out of the estate and putting them into the irrevocable trust.
An alternative use for life insurance is to replace some or all of the value of assets going to charity.
For example, let’s take a $40 million estate today and assume no compression strategies. Subtracting the $13 million of estate tax exemption per husband and wife would still leave approximately $14 million of assets subject to a 40% Federal estate tax. (This does not include any state tax which might also be charged on the assets.)
If we elect to have the $14 million go to charity or our their family foundation, life insurance could be purchased to replace the value of the assets going to charity.
Further, we can in most cases dramatically reduce the cost of life insurance (which is already paying for the estate taxes at a substantial discount) by leveraging the purchase of the life insurance. That is, we have banks willing to loan purchasers of life insurance the money to pay premiums for that insurance.
Thus, if we are looking to replace the value of assets going to charity, we can buy life insurance and pay the majority of the cost using loans from specialized lenders. This is a very sophisticated approach, but it’s also has a number of steps involved. This needs to be done correctly. We are partnered with the nations largest leveraged insurance marketer to make sure the I’s get dotted and the T’s crossed.
Grantor Retained Annuity Trust
While I am not a fan, the GRAT is another type of irrevocable trust. The assets go into the trust, which pays an income to the grantor each year (hence, just like an annuity.) You set the number of years to receive the income. At the end of that timeframe, the beneficiary will receive everything remaining in the GRAT… and therefore escape those pesky estate taxes!
But if the grantor dies before the end of the term, unfortunately the assets remain in the estate for tax purposes. Hence my dislike for this strategy. I want certainty for clients in their planning! However, you can think of this as a “heads-you-win, tails-you-break-even” strategy.
“Now wait a moment,” you’re probably thinking. “My children are grown and I’ve been buying more pairs of baby socks for the grandkids than seems reasonable. Surely children didn’t grow so fast when mine were young. How does funding a 529 help reduce my estate taxes?”
Well…many reasons. First, the good ol’ days of affording college tuition while working a summer job have gone the way of walking uphill to school both ways in the snow. The average price of tuition has gone up 3,009% since 1969. So your grandchildren will either need some generous help from you and everyone else they know or be in student debt until they start collecting Medicare.
Second, you can fund 529s for more than just your direct descendants. Almost anyone tangentially related to you is allowed.
The annual gift exclusion is now $17,000 per beneficiary. Therefore, you can contribute up to $17,000 a year for each 529 (assuming you don’t also give birthday or Christmas gifts to them! In which case, lower the 529 contribution appropriately.)
Or, there is a special exemption allowed whereby you could do a lump sum of $85,000 in one year to cover the first five years of contributions all at once. (But, remember those Christmas and birthday gifts are included in that $85,000!)
Third, the SECURE Act 2.0, which we discussed in a previous newsletter, now allows up to $35,000 of unused 529 funds to roll into a Roth IRA without any tax penalty.
As an example, maybe one of your special-beyond-belief grandchildren decides that they don’t want to be a doctor, but they really like playing with “wires.” That is, the job security of electricians won’t be replaced by AI or robots any time soon. They can use up to $35,000 of the remaining funds in their 529 when they finish trade school to turbo-charge their retirement.
If we want to get really creative, we can “freeze” the value of the assets in the estate by creating a preferred interest and a growth interest in certain assets. You keep the preferred interest in your own estate and give away the growth to your beneficiaries. (Chapter 14 in the IRS code.)
Needless to say, this strategy is used far less times than the techniques above. This falls under “Professional driver on a closed course. Do not attempt.” If you think this sounds right for you, schedule a complimentary 20-minute call with me by emailing email@example.com. There are some powerful potential benefits for situations and estates where this might apply.
What if Congress Allows the TCJA to Sunset?
There’s always a worry that taxes will go up since they’re at near-historic lows. Letting the TCJA of 2017 sunset will give the Federal Government and the states a little bit more revenue, especially now that we’re in “The Great Wealth Transfer” (younger generations inheriting an estimated $73 trillion from Boomers between 2020 – 2045.)
While we don’t have a crystal ball, I expect Congress will allow the TCJA to sunset, dropping the Federal exemption from nearly $13 million per person back down to (best guess) $7 million.
Knowing that it may likely sunset on 12/31/2025 and having a plan in place will pass more of your wealth without estate taxes.
A side benefit of having a plan is it forces you to realistically assess the value of your estate. Therefore, you can see whether you have, or will have, an estate tax issue assuming the exemption amounts are reduced as most expect. Plus, it will account for the state death taxes if you live in some place like Oregon with the $1 million state exemption.
This is All Nice ... What Should I Do?
- The first step is not paying estate tax at all
- The second step is paying estate taxes as inexpensively as possible
- Third, consider gifting assets with a temporary reduction in value (such as community bank stock or creating valuation reductions such as the Freeze Technique described above.)
Side note: In some cases, the executor can take advantage of IRS Code Section 6166. It allows for paying estate taxes over time where there is a “closely held” business involved.
Having a thoughtfully designed plan in place to eliminate or substantially reduce estate taxes often brings meaningful relief.
Additionally, write your congressmen/women and ask them to renew the provisions of the TCJA. It’s a long shot that they’ll listen. Nonetheless, members of congress pay special attention to personally written correspondence.
If you’re looking for a simple way to address eliminating estate taxes, here it is. Give away any assets (to charity or your family foundation) subject to estate tax at the time of your death. And replace the assets with the amount desired by purchasing life insurance paid for largely or completely with tax deductions.
Then call it a day!
Simply put, time is swiftly running out. December 31, 2025 will be here in a nanosecond. Once it is, it’s too late to achieve meaningful estate tax reduction for larger estates.
As American Stateman and Founding Father Benjamin Franklin said, “But in this world nothing can be said to be certain, except death and taxes.”
With thoughtfully sitting down with professionals, we can make estate taxes optional ... “Imagine That™!”
P.S. Some States are Piling On, Too
If you live in one of the following 12 states or the District of Columbia – lucky you – they also impose their own estate taxes … many with much lower limits than the Federal exemption.
But wait … there’s more!
Six states have inheritance taxes. That’s what your heirs pay for any received inheritance.
Now, if you live in Maryland, you might be asking, “R. J., are you sure my home state is supposed to be on both lists?” Well, I wish I had happier news for you, but you and your heirs get the tax triple-whammy award. But before you decide to pack up your home and move, start with some of the strategies outlined above to minimize how much of your hard work gets redistributed through “involuntary philanthropy,” AKA taxes.
Imagine That™! is a complimentary monthly newsletter provided by Wealth Legacy Group®, Inc. that addresses various topics of interest for high-net-worth and high-income business owners, professionals, executives and their families. Sign up to receive our monthly newsletter here.
R. J. Kelly, Wealth Legacy Group®, Inc. – June 2023
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