TRUSTS & TAXES: CAPTURING A SECRET BENEFIT

The amount of assets that you can pass free of federal tax at death has increased over the past decade. 

This federal estate tax exemption is set to decrease substantially, a drop that will likely be sooner rather than later due to the political situation. 

At the moment, the federal estate tax exemption is $11,580,000 per person or $23,160,000 for a married couple combined. No federal estate tax must be paid if a person passes with assets under those amounts; however, if a person/couple dies with assets over those amounts, the value of assets over those amounts is taxed at 40%. 

It is not common to see a federal estate tax bill since most Americans do not have assets over the exception amount.  It is also interesting to note that any assets left to spouses or charities are not subject to federal estate tax. 

The federal estate tax cap of $11,580,000 was passed into a 2017 law that temporarily doubles the existing exception. The exception will continue to increase, adjusting to inflation until the end of 2025. If the law is not changed, the exception will return to its halved amount on the first day of 2026. 

The reduction of federal estate tax exceptions by half in 2026 will greatly impact people with high net worth. For example, if a man died in 2020, leaving $11,580,000 to his children, there would not be any federal estate tax due because the value of the assets did not go over the exception. However, if we ignore inflation, in 2026, the federal tax exception would be only $5,790,00 (half of what it was in 2020), and the man’s death in 2026 would trigger a federal estate tax of more than $2,300,000.  This would make the children receive over two million less due to the death taking place after the exception returned to its previous value. 

Fortunately, there are ways to obtain the benefits of the current federal estate tax exception without dying. By using taxable gifts, you can use the federal estate tax exception. This should be done sooner rather than later, given the current administration, which could return the exception to its previous level before 2026. 

There was some concern that using the increased exception during life would cause the IRS to issue some penalties. However, this is no longer a valid concern as the IRS has issued regulations indicating no penalty will be issued.

Aside from taking advantage of the current amount of the exception, gifting during life allows you to maximize your exception in the long run.  For example, a woman who established a trust with assets worth $11,580,000 for the benefit of her children as a gift can have those assets increase in value to $30,000,000 by the time of her death.  The woman has then used her exception to save an additional $7,000,000 in federal estate tax or 40% of the increase in value of the assets. 

There are states which also impose estate taxes. Most estate taxes at the state level have a rate under the federal estate tax; however, the amount of the estate tax exception at the state level is also usually less. By making use of the federal estate tax exception during life to diminish the value of your estate, you can also minimize the state-level estate taxes. 

If the value of your assets potentially exposes you to federal estate tax liability and you have not used your federal estate tax exception, you should do so as soon as possible before you lose the chance to do it. 

At TMW Advisory, we believe a comprehensive plan is vital to helping you achieve your goals. We believe finding the right strategy for you and your financial goals is most important. If you would like assistance in connecting the dots between your investment strategy and financial goals, schedule a call with a member of our TMW team.