The federal lifetime gift and estate tax exclusion will increase from $12.06 million in 2022 to $12.92 million for 2023. There could also be increases for inflation for both 2024 and 2025. That’s the good news.
The bad news for some wealthy clients and their advisors: Barring a change in tax law, these high thresholds are only temporary. Under the sweeping tax overhaul enacted in 2017, known as the Tax Cuts and Jobs Act, the increase in the exemption will sunset after 2025, sending the estate and gift tax exclusion back to its pre-2017 level of $5 million, adjusted for inflation.
Estimates for tax year 2026 vary, but it is expected the amount will be as much as $6.8 million per person.
To be sure, most Americans do not have estates large enough to worry about these limits. But for high-net-worth clients who may be affected, there are important estate planning issues to consider.
Note we are only discussing the implications for the federal estate and gift tax exemption. Various states have their own estate and inheritance tax rules.
There is an annual estate and gift tax exclusion that is adjusted each year for inflation. Gifts at or below that amount do not count toward the lifetime exemption. For 2022, the annual exclusion is $16,000 to any single recipient. For 2023, this increases to $17,000.
For clients who have not made any gifts prior to 2026, their lifetime gift and estate tax exemption will revert to 2026 levels, with any increases in subsequent years applying. If they have made gifts prior to 2026, there could be a couple of scenarios.
For clients with assets in excess of the exemption amounts that will be in place after 2025, there are some steps they can take to reduce their taxable estate and/or take advantage of the current limits. What is best for a particular client will vary based on their own unique situation including the nature of their heirs, marital status, their own health situation and a host of other factors.
One solution is to encourage your client to spend down some of their assets. This does not mean frivolous, indiscriminate spending but rather encouraging them to enjoy their money. Go on that around-the-world vacation they’ve always wanted to take. Travel to out-of-town sporting events or to attend theater performances. Dine at those top-notch restaurants.
Depending on how large their estate is, their age and health, this type of spending may not get their estate under the future exemption limits, but these expenditures can add up over time and fit with an overall plan. Many people who have accumulated large asset bases tend to be frugal. Encourage your clients to enjoy the fruits of their hard work and diligent savings and investing habits.
For clients who are charitably inclined, gifts to charity are an excellent way to reduce the size of their taxable estate. Current-year gifts of cash, appreciated securities and other assets can provide a tax deduction that can be used to reduce current-year income taxes in addition to reducing assets. Clients can also avoid having to pay capital gains taxes on the sale of these holdings.
For clients who wish to benefit one or more charitable organizations over time, a donor-advised fund (DAF) might be a good solution. A DAF allows your client to make an upfront deductible contribution to a managed account and then parcel out donations to eligible charities over time. They can make a series of deductible contributions over time, this can allow them to take a measured approach to charitable giving as a way to reduce their taxable estate.
Gifting appreciated securities provides several benefits. They can receive a current year deduction based on the market value at the time of the gift. They would not incur any capital gains taxes as they would have if the securities were sold. And the donation reduces the size of their estate.
Married couples have double the individual lifetime estate and gift tax exemption. For 2023 this would mean that a married couple has a combined exemption of $25.84 million. With a few exceptions, assets can be left to a surviving spouse on an unlimited basis with no estate tax consequences. One exception is that a non-citizen spouse cannot benefit from the unlimited marital deduction rules.
There are a number of estate planning opportunities available for married clients. One option is that a surviving spouse can take advantage of a deceased spouse’s unused lifetime exclusion in some cases. This can allow the surviving spouse to leave a larger amount to their heirs than just their own lifetime gift and estate tax exclusion would allow
While nobody would advocate that anyone get married for financial reasons, including the estate tax exemption, if you have a single high-net-worth client contemplating marriage, you should discuss the ramifications of marriage on the exemption amount, as well as the planning opportunities available.
The death benefit from a life insurance policy would generally be included as part of your client’s taxable estate. There is one notable exception: policies held in an irrevocable life insurance trust or ILIT.
Your client can transfer an existing policy into an ILIT; however the policy must be in the ILIT for at least three years in order to remove the death benefit from their estate. If your client were to die within the three-year time frame, the death benefit would revert to being part of their estate and would be taxable if applicable.
If your client purchases a new policy inside of the ILIT, the three-year rule does not apply; the death benefit would be removed from the grantor of the trust’s estate immediately. Depending upon the nature of the policy and your client’s situation, they might consider either a policy paid with a single premium, or a policy where the premiums are gifted to the ILIT as they become due.
The main advantage of an ILIT is that it offers the ability to allow the death benefit to go to the beneficiaries of the trust without being subject to federal estate taxes. For clients with larger estates that will exceed the post-2025 exemption limits, this can be a way to pass on a large death benefit without worrying about the effect of federal estate taxes.
Giving assets to a trust can be another way to pass assets to heirs and beneficiaries without incurring estate taxes on this transfer of wealth. Typically this transfer will need to be made to an irrevocable trust; revocable trusts allow the grantor to maintain a higher level of control over the assets and generally do not offer the benefit of being exempt from estate taxes.
An ILIT discussed above is an example of an irrevocable trust. In other cases, your client as the grantor could transfer cash, securities or other assets into an irrevocable trust. While these transfers to fund the trust will generally be considered as gifts, the main benefit from an estate planning perspective is that the assets inside of the trust have the opportunity to grow without being taxed. These appreciated assets can then be passed on to the beneficiaries of the trust federal estate tax free.
Charitable trusts may be another option for your client. With a charitable remainder trust, appreciated securities or other assets are contributed to the trust. Your client receives an immediate charitable deduction, they then receive an annual income stream for the remainder of their lives. Upon their death, the assets in the trust revert to the charity or charities of their choosing. There are no estate taxes due upon their death.
With a charitable lead trust, assets are contributed to the trust during the grantor’s lifetime or upon their death. During the trust term, payments are made to one or more charitable beneficiaries. After the term of the trust, the remainder of the assets in the trust are distributed to the beneficiaries, often family members. A charitable lead trust can offer income and estate tax benefits.
There are a number of additional trust-related strategies that can be considered as well.
The sunset provisions pertaining to the lifetime estate and gift tax exclusions kick in after 2025. The lifetime exclusion will roughly be cut in half from its present level. For high-net-worth clients, this means a drop from the 2023 levels, plus any inflation increases for 2024 and 2025. Using 2023 numbers, the exclusion limits are $12.92 million and $25.84 million for a married couple. This is projected to drop to $6.5 million to $6.8 million for individuals and $13.0 million to $13.6 million for married couples.
Between now and 2026, there are a number of strategies you and your clients can consider to utilize the higher exemption limits and/or to ensure that they maximize the amounts given to their desired heirs. The items listed above are just a few strategies that can be considered. You will want to be sure that your higher-net-worth clients work with a qualified estate planning attorney and a tax specialist knowledgeable in these areas.
Even for clients not currently above either the pre- or post-2025 thresholds, there are some solid estate planning ideas that can be used to minimize the effect of future gift and estate taxes and maximize the amounts given to their desired heirs.
Beyond planning for the reduced federal estate and gift tax exemption, you will want to work with clients to be sure they are taking the right steps to minimize the effect of their state’s estate taxes if applicable.