The Sunset of the Estate and Gift Tax Exemption: What Are You Doing About It?

I spent a couple of decades of my career helping the ultra affluent (& their advisors) strategize and procure awesome underwriting offers for their life insurance for the purpose of estate planning. This topic is very near and dear to me so let's talk about some basics to start with.

Why Should You Care?

Look for my next article that talks about this topic. But in essence: If your estate is worth more than the exemption, the part over that amount is taxed. The federal estate tax rate gets higher as the amount over the exemption increases, up to 40%.

You should start worrying about estate taxes if:

• Your net worth exceeds the exemption limit of your state (if it imposes estate taxes).
• Your net worth is close to or exceeds the federal exemption amount.
• You anticipate significant growth in your estate that might bring its value close to these thresholds in the future (this is big and often overlooked by people so consumed with growing their investments and estate)

What is the Lifetime Gift Tax Exemption?

The lifetime gift tax exemption is a critical component of estate planning. It represents the amount you can give away during your lifetime without incurring gift tax. The Tax Cuts and Jobs Act of 2017 brought significant changes to this domain, temporarily doubling the federal estate and gift tax exemptions until the end of 2025. This increase shifted the exemption from $5 million to $10 million per person, adjusted annually for inflation. Currently, for 2023 and 2024, the exemption stands at $12.92 million and $13.61 million per person, respectively.

The Unified Nature of Estate and Gift Taxes

It's essential to understand that the estate and gift taxes are unified. This means any gifts made during your lifetime reduce both your available gift tax exemption and your estate tax exemption at death, dollar for dollar. However, this increased exemption is set to expire at the end of 2025. Beginning January 1, 2026, the exemption amount will revert to the pre-2017 law's $5 million cap, which, when adjusted for inflation, is expected to be around $7 million.

Implications for Estate Planning

This impending change offers a unique opportunity for significant tax-free transfers to beneficiaries, potentially reducing or eliminating federal estate tax liabilities. Post-2025, the exemption will halve, and the chance to utilize the temporarily increased exemption will disappear.

Additionally, it's important to note the federal estate tax's top rate of 40%, along with various state estate and/or inheritance taxes. Currently, twelve states and the District of Columbia have estate taxes, and six states impose inheritance taxes, with Maryland having both.

Estate Taxes by State as of the date of this article

As I write this article, here are the inheritance tax rates for the States that impose them:

1. Iowa: The tax rate varies from 0% to 15%, depending on the relationship of the heir to the deceased. Close relatives pay lower rates, while distant relatives and non-relatives pay higher rates.
2. Kentucky: Tax rates range from 0% to 16%. The rate depends on the relationship to the deceased, with higher rates for more distant relatives.
3. Maryland: Inheritance tax is a flat rate of 10%, but immediate family members are exempt.
4. Nebraska: Tax rates range from 1% to 18%, depending on the heir's relationship to the deceased and the amount inherited.
5. New Jersey: The rate varies from 0% to 16%, depending on the relationship and the value of the inheritance.
6. Pennsylvania: Tax rates are 0% for surviving spouses and parents inheriting from children aged 21 or younger, 4.5% for direct descendants and lineal heirs, 12% for siblings, and 15% for other heirs.

It's important to note that ALL tax laws can change, and the specific circumstances of each inheritance can affect the tax rate. Consulting with a tax professional or an attorney for the most current and relevant information is always recommended.

Estate Planning Tools: ILITs, SLATs, and GRATs

To maximize the benefits of the current exemption, consider tools like Irrevocable Life Insurance Trusts (ILITs), Spousal Lifetime Access Trusts (SLATs), and Grantor Retained Annuity Trusts (GRATs).

1. ILIT: This trust owns life insurance policies to keep death proceeds out of the taxable estate. The ILIT pays the policy premiums, and after the grantor's death, the proceeds provide liquidity for any due estate taxes.
2. SLAT: Created by one spouse for the other, it allows married couples to enjoy gift tax-free access to gifted property, potentially including life insurance distributions.
3. GRAT: This trust enables the grantor to retain an income stream for a set period, with the remainder passing to beneficiaries potentially with minimal or no gift tax.

The Urgency of Action

If you plan to give away more than the inflation-adjusted $5 million, it's crucial to act swiftly. Using these trusts can facilitate asset transfer while minimizing gift taxes, ultimately enhancing your legacy.

The Sunset is Near: Are You Prepared?

As we approach the sunset of the doubled federal exemption, consulting with legal or tax advisors to set up trusts like ILITs, SLATs, and GRATs correctly is imperative. This proactive approach is key to maximizing your estate planning strategy in light of the upcoming changes.

For more information or to discuss your specific situation, please feel free to reach out to us at contact@peachinsurance.net. We're here to help you navigate these complex issues. Note that we are not attorneys or CPAs (you should consult your own) but we can help you understand how insurance is used in these situations. We also have a track record of helping with effective insurance for estate planning strategies and getting awesome underwriting offers - which translates to maximizing the benefit you get for your money and making sure your legacy is protected, your heirs - happy!