How to Plan for the 2025 Sunset of the Federal Estate Tax Exemption  | Howe & Rusling (2024)

• January 12, 2024

Gifts, Inheritance, and Wealth Transfers

Fundamentally, you have a right to transfer your wealth in the U.S. Transfers from your estate allow property, money and other assets to move from generation to generation, or person to person. Often, these transfers are setting up future generations to inherit the family home, the family business, or the family’s hard-earned dollars. Other times, the transfer is philanthropic, and honors causes close to an individual’s heart. Our society has depended on wealth transfers since modern times. However, the government gets involved when you transfer your wealth. The federal government (and some states) levies a tax on wealth transfers. The good news is that the federal government does allow us to transfer a certain amount of wealth to others tax-free. This tax-free amount is known as the federal estate and gift tax exemption amount. Before we can talk about what the taxes and exemption amounts are and how to utilize them, we have to talk about what is included in your estate.

What is Included in Your Gross Estate?

Most people think of just their portfolio or their liquid assets when calculating the value of their estate. This is incorrect. The term “gross estate” refers to the total dollar value of an individual’s property and assets at the time of his or her death. This figure does not factor in any liabilities, such as debts owed and taxable events triggered by one’s death. When those charges are deducted, the sum represents the net value of an individual’s estate. The includable property may consist of cash, investments like stocks, bonds or private equity interests, real estate, artwork, valuables, automobiles, boats, insurance, trusts, annuities, business interests, real estate, and nearly any other asset. The total of all of these items is your “gross estate.”

It is important to know the value of your gross estate, so you know if you are below the tax-free transferable value for purposes of lifetime gifting or bequests from your estate at your death.

Federal Gift, Estate, and Generation Skipping Transfer Taxes

Gift and estate taxes apply to transfers of money, property and other assets. Gift taxes are imposed on transfers during a lifetime that exceed the exemption limits, and estate taxes are imposed on transfers at death that exceed the exemption limits. The generation-skipping transfer (GST) tax is imposed on transfers to grandchildren and more remote descendants that exceed the exemption limits so transferors cannot avoid transfer taxes on the next generation by “skipping” a generation. The GST tax is levied in addition to gift or estate taxes and is not a substitute for them.

The 2017 Tax Cuts and Jobs Act (TCJA) nearly doubled the lifetime estate and gift tax exemption from $5.6 million for individuals and $11.18 million for couples, to $11.18 million for individuals and $22.36 million for couples, indexed for inflation after 2018. For 2024, that is $13.61 million for individuals and $27.22 million for couples.

The TCJA provisions are currently scheduled to expire at the end of 2025, and the inflation adjusted estate tax exemption is anticipated to land at around $6.8 million effective January 1, 2026. Given this good news was set to sunset, many feared that gifts made using the increased amount would be clawed back when the sunset occurred beginning in 2026.

Fortunately, the anti-clawback rule was codified in 2019 and clarifies that an individual or estate won’t be taxed on completed gifts that were tax-free and made before 2026. Under the anti-clawback rule, after the sunset, a decedent’s exemption will be the greater of what they have previously gifted or the current amount, which, again, we anticipate being around $6.8 million in 2026. While the exemption currently remains elevated, we’re afforded a rare estate planning opportunity.

Why is this window of time to plan important?

If you don’t plan, you can leave money with the government instead of with your beneficiaries. An effective estate plan often includes a combination of strategies, such as planned gifting, a variety of trusts, and charitable planning. With the increased exemption amount through 2025, certain lifetime gifting strategies can be implemented now, before the sunset, to reduce estate values and estate tax liability.

While this article won’t go into the weeds on specific strategies, there is usually a level of relinquishing control (to some extent) of assets now for your beneficiaries or future beneficiaries. You may be able retain control to a certain extent over beneficiaries, however, with factors such as when they receive your gift and what they can spend it on. Part of the planning is making sure you only engage planning strategies as to a certain amount of your assets where it won’t impact your lifestyle. Plans are not one-size fits all. Therefore, collaborating with both your estate and financial planning team results in a sensible and customized strategy for you and your estate.

Developing a comprehensive and cohesive financial and estate plan is first based on an understanding of your overall financial picture. An accurate picture of your balance sheet is a crucial starting point to understand your estate’s growth and predicting when, and if, you will have a taxable estate. Once you have that base built, your estate plan can be formed through an integrative process of detailing your projected lifetime spending, as well as your legacy goals. Then you can decide what assets and how amounts can be gifted, either outright or in trust, or in some other strategic manner to produce estate tax savings.

Savings Example

What can these tax savings potentially look like? In this example, if we assume an unmarried individual’s estate is valued at $16 million, and the full 2024 exemption ($13.61 million) was gifted and there is no growth on the remaining assets, then the taxable estate in 2026 would be valued around $2.39 million. When the elevated exemption sunsets in 2026, the potential estate tax liability would be $956,000.

On the other hand, if no gifts were made, then at the sunset in 2026, the taxable estate would remain at $16 million. In that case, the potential estate tax liability would be $3.68 million. That is reached by assuming the amount over the assumed exemption amount is taxed at the maximum federal rate of 40%.

CAUTION: State-Based Estate Tax

Many states also have an estate tax, and state exemption levels are lower than the federal level, so it is crucial to consider the state impact as well as the federal.

At present, 12 states and the District of Columbia have an estate tax that applies at death: Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. States such as Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania have an inheritance tax. Maryland has both an estate tax and an inheritance tax.

Any estate planning should take into consideration your state’s rules and estate tax laws. You want to always plan carefully for both your state and the federal estate tax.

For instance, New York has an estate tax “cliff” that is relatively easy to trigger without planning. The New York estate tax threshold is $6.94 million in 2024. That number will keep going up annually with inflation, unless it is changed by legislation. This means that if a person’s estate is worth less than $6.94 million and they die in 2024, the estate owes nothing to the state of New York. If the estate exceeds the $6.94 million exemption by less than 5%, it only pays taxes on the amount that goes over the threshold. However, if the total value is more than 105% of the exemption amount, taxes are paid on the entire estate. This is known as the estate tax “cliff.”

Here’s an example of how that works: 105% of $6.94 million is $7,287,000. If your estate is worth between $6,940,000 and $7,287,000 in 2024, you only pay tax on the amount that exceeds $6.94 million. So, if your estate is worth $6.99 million, your taxable estate is only $50,000. If your estate surpasses $7,287,000, all of your estate is taxable down to the first dollar. So, if your total estate is $7.75 million, for example, you will pay estate taxes on all of that.

This cliff might be easily avoided just by strategically gifting some assets or re-titling some assets in the name of your spouse. A little planning could save you a significant amount in taxes, if not completely avoid state estate tax.

Time is of the Essence

The increased exemption amount is set to sunset on December 31, 2025. If no legislation is introduced and passed extending the increased exemption amount, that means that you have a little under two years to 1) engage an estate attorney and your financial advisor, 2) come up with an appropriate planning strategy with those professionals, and 3) execute that plan. Outright gifting, charitable gifting, and gifting to a trust all take different approaches and require different lead times to properly execute.

If you will be near or over a taxable estate and if your goals for your money align with passing on your wealth to the next or future generations or giving to a charitable organization, now is the time to act. You can pass on more of your wealth and leave less money on the table for the government. Utilize the rare opportunity to save on estate and gift taxes by reviewing your estate and financial plans now.

Disclosures:Adviser is not licensed to provide and does not provide legal advice to clients. Advice of qualified counsel should be sought to address any specific situation requiring assistance from such licensed individuals. Any information provided by Adviser is for illustrative and educational purposes only, is intended to provide general information only and should not be construed as legal advice nor does its preparation form an attorney-client relationship between Howe & Rusling, AM Gray Law or Andrea M. Gray and the client. This communication may include forward-looking statements, although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor. Rules and regulations are current as of the date published and are subject to change without prior notice. Investment strategies, philosophies, and allocation are subject to change without prior notice. While H&R believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.