Estate planning is an essential task for everyone, especially given the ever-changing landscape of the federal estate tax. In 2023, the exclusion amount is at a record high, but that’s set to change in the coming years.
Here’s what you need to know about the federal estate tax, its upcoming changes, and how it interplays with the gift tax.
The 2023 Federal Estate Tax Exclusion and Rate
For 2023, the federal estate tax exclusion is $12.92 million. This means that if the total value of your estate is below this figure, it will not be subject to the federal estate tax. Anything above this threshold, however, is taxed at a maximum rate of 40 percent. This exclusion is quite generous but won’t last indefinitely – more on that later.
Special Provisions for Married Individuals
If you are married, the tax law offers additional advantages. The marital deduction allows for unlimited tax-free transfers of assets between spouses. This essentially means that the surviving spouse can inherit an unlimited amount without any federal estate tax liability.
Another benefit for married couples is that the estate tax exclusion is “portable.” If one spouse dies and doesn’t use up their entire exclusion, the remaining amount can be transferred to the surviving spouse. This allows couples to effectively shield up to $25.84 million from federal estate tax in 2023.
Exclusion Amount Set to Drop in 2026
The current high exclusion amount won’t last forever. Due to a provision in the Tax Cuts and Jobs Act of 2017, the exclusion is set to drop to $5.49 million on January 1, 2026. This significant decrease means that more estates will be subject to the federal estate tax. Therefore, planning your estate with this upcoming change in mind is crucial.
Understanding the Gift Tax and Unification with Estate Tax
The gift tax is another important aspect of estate planning. It’s a tax on transfers of money or property to another person while receiving nothing, or less than full value, in return.
In 2023, the annual gift exclusion is $17,000 per recipient. This is an exclusion that is separate from the multimillion-dollar estate tax exclusion.
However, the gift tax and the estate tax are unified. This means that the $12.92 million exclusion applies to both your lifetime gifts that exceed $17,000 within a calendar year to any individual and your estate. In other words, you are reducing your available estate tax exclusion if you give large tax-free gifts in excess of $17,000 in a tax year to any individual.
Timing Is Everything: Use the High Exclusion Now
Given that the estate and gift tax exclusion is set to drop dramatically in 2026, consider taking advantage of the current high exclusion. You can use this period to gift assets or set up trusts, thereby reducing the value of your estate that could be subject to taxation in the future.
State-Level Estate Taxes
In addition to federal estate taxes, 12 states in the U.S. also impose their own estate taxes. These states are Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. Each state has its own set of rules, rates, and exclusion amounts, which can be significantly lower than the federal exclusion.
South Carolina, where we practice law, is not one of the states, but here’s a crucial point many people overlook: Even if you’re not a resident of one of these states, you could still be subject to their state-level estate taxes.
How? If you own property in one of these states and the value of that property exceeds the state’s exclusion amount, you’re liable for estate tax in that state.
Out of State Liability
This can be a complex issue, especially if you own multiple properties across various states. Each state’s estate tax exclusion is different, making estate planning even more complicated. In fact, some are as low as just $1 million.
Given the dual complexities of federal and state-level estate taxes, professional guidance is indispensable. An estate planning lawyer can help you navigate these intricacies, ensuring you minimize your tax liabilities both now and for your heirs in the future.
Strategies for Estate Tax Efficiency: Beyond Gifting
While gifting is a straightforward way to reduce your taxable estate, other advanced strategies can offer even greater tax efficiency. Here are some options that go beyond simple gifting:
Utilizing Irrevocable Trusts
Various types of irrevocable trusts can be used to achieve estate tax efficiency:
- GRAT (Grantor Retained Annuity Trust): This allows you to transfer assets to beneficiaries while retaining an annuity payment for a certain period. If you outlive the trust term, the assets that remain pass to your beneficiaries tax-free.
- QPRT (Qualified Personal Residence Trust): With a QPRT, you can transfer your primary residence or vacation home to an irrevocable trust while retaining the right to live in it for a number of years. If you outlive the trust term, the property passes to your beneficiaries without being subject to estate tax.
- GST (Generation-Skipping Trust): This trust allows you to transfer assets to beneficiaries who are at least 37.5 years younger than you, typically grandchildren. In so doing, you skip a generation and a round of taxation that would otherwise be imposed.
Stepped-Up Basis for Appreciated Assets
One of the most effective ways to avoid capital gains tax on appreciated assets is to hold onto them until death. The “stepped-up basis” rule allows the asset’s basis to be adjusted to its fair market value at the time of death, eliminating any capital gains that accrued during your lifetime.
These advanced strategies often involve intricate legal and financial planning. Therefore, consulting an estate planning lawyer to tailor these instruments to your specific needs is crucial. They can help you navigate the complexities of estate tax laws and ensure you’re leveraging all available options to minimize your estate’s tax liability.
We Are Here to Help!
Our doors are open if you are ready to work with a Bluffton, South Carolina estate planning lawyer to create a custom-crafted plan that is ideal for you and your family. You can send us a message to set up a consultation appointment, and we can be reached by phone at 843-815-8580.
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