John was sitting at his desk. It was 9:00 o’clock at night; another busy day complete. Everyone else had left the office and was spending time at home with their families and friends, but John stayed late, as usual, to make sure the business was in order.
John had built this business from scratch for the past 30 years, and there’s no doubt it was a success; however, he couldn’t help thinking about all of the sacrifices he made to get to this point – the lean times at the beginning, the late nights and long weekends, missing quality time with his kids throughout the years.
Now at 9:00 p.m. his thoughts shifted to the meeting he had with his estate attorney earlier in the week when he learned that a large portion of what he had built would be subject to estate tax. Despite paying his taxes faithfully throughout the years, the business could not simply be passed to the next generation without Uncle Sam taking another bite of the apple. Concerned, John turned out the lights and headed home to get ready for another busy day tomorrow.
Stories like the one described above are happening every day in every city throughout America. The excitement and promise of the American Dream has led thousands of people to start businesses, and eventually, become successful through years of hard work and persistence.
In many cases, one of the primary motivations for these success stories is not only to provide a better life for the individuals involved but also for their families. So, it is not surprising that they are disappointed at the thought of a large portion being taken by the government instead of passing to those they care about.
While the realities of estate taxes are challenging, the good news is there are opportunities to maximize the portion of your future estate that will be passed to your heirs if proper planning is implemented early with help from a qualified team of professionals.
Key Takeaway:
Certain high-net worth individuals will be required to pay estate taxes when they pass away. Proper planning now, can minimize the taxes owed.
Understanding the Basics:
To start, it’s important to understand the basic rules about estate taxes. The United States has implemented a unified gift and estate tax system which allows individuals to gift or bequeath a threshold amount of assets to others without any tax owed upon the gift or transfer.
The system is considered “unified” because it doesn’t matter whether the gifts are made during life or through the estate at death. In other words, the tax-free transfer amount allowed is a combined limit regardless of when the transfer occurs.
In 2017, President Trump signed the Tax Cuts and Jobs Act of 2017 (TCJA). This law made significant changes to individual and corporate income taxes, but it also made important changes to gift and estate taxes. Specifically, the TCJA doubled the amount that individuals could pass to others free of estate or gift taxes. This threshold amount is called the basic exclusion amount (BEA).
Currently, in 2024, the basic exclusion amount is $13,610,000 per individual. Married couples can elect “portability” which allows a surviving spouse to retain any unused exclusion from the death of their spouse. As a result, married couples effectively can transfer $27,220,000 to the next generation without paying any federal estate tax.
With exemption levels currently this high, many individuals don’t anticipate having a federal estate tax liability. This is expected to change at the end of 2025. The provisions of the Tax Cuts and Jobs Act of 2017 that doubled the basic exclusion amount, were not permanent and are scheduled to expire on January 1st, 2026.
When this occurs, the basic exclusion amount will revert back to half its current level. Adjusting for inflation, that means the basic exclusion amount in 2026 will likely be close to $7,000,000 and the exemption for a married couple that elects portability will be around $14,000,000.
While $14,000,000 is still a substantial estate, the number of individuals who will be impacted at this level is markedly higher than the number impacted under the temporary TCJA rules.
Although not the focus of this article, another important point to keep in mind is that multiple states also impose an estate tax and may have lower exemption limits than the federal basic exclusion amount.
For example, Minnesota imposes an estate tax with an exclusion of $3,000,000 and does not allow portability between spouses. Accordingly, individuals may need to consider estate planning specifically for state level taxes despite being under the thresholds for federal estate taxes.
Key Takeaway:
The high federal gift and estate tax exclusions are expected to be cut in half at the end of 2025 unless Congress acts proactively.
Why It Matters:
For individuals who expect to have combined lifetime gifts and estates in excess of the post-2025 basic exclusion amounts, important planning should occur now to reduce the overall tax burden your family will ultimately face.
For example, individuals who choose to use the higher lifetime exemption while it remains in effect will not have the exemption clawed back after it reverts in 2026. However, it is important to understand what this means. The IRS has clarified that:
“The regulations provide a special rule that effectively allows the estate to compute its estate tax credit using the greater of the BEA applicable to gifts made during life, or the BEA applicable on the date of death.”
To simplify, this means that individuals who choose to make large gifts now, can lock in the higher exclusion amount currently in effect. However, any gifts made during life will use up the lower exclusion amount first. In other words, if an individual makes a gift of $2,000,000 before the end of 2025, the gift will be treated as coming from the reduced exclusion of $7,000,000 not the higher exclusion of $13,610,000.
In order to lock in the higher exclusion amount, the individual must give more than the $7,000,000 at which point anything in excess of the $7,000,000 begins to lock in a portion of the higher exclusion. Thus, individuals who choose to lock in the higher exclusion must commit to gifting a substantial amount of assets.
Nevertheless, gifting a substantial amount of assets before the end of 2025 can provide significant tax savings and is worthy of review with your advisors and attorneys. To provide an example, consider a married couple with a net worth of $25,000,000 who have previously made $500,000 of lifetime gifts.
Currently, their remaining combined basic exclusion amount exceeds their net worth, so no estate taxes would be due if they passed away this year. However, if they were to pass away in 2026 with the same $25 million-dollar net worth, they would owe $4.6 million dollars in federal estate taxes.
Accordingly, those who can afford to make large gifts prior to the expiration of the TCJA have the ability to lock in significant estate tax savings.
The decision to gift a substantial amount of assets is typically an easier decision for individuals who have extremely large estates (i.e. $50M or higher). They benefit from the ability to give enough assets away to lock in the full exclusion while still having plenty left over to fund their ongoing lifestyle. For individuals and families without the same cushion, it is a much more difficult decision and requires thorough planning with a qualified team.
Regardless of the situation, appropriate planning can provide significant tax savings for your family.
Key Takeaway:
Those who can afford to lock in the current basic exclusion amount before it sunsets have the ability to realize substantial tax savings for their families.
Planning Options:
Individuals who are interested in planning for the upcoming sunset of the TCJA and the corresponding reduction in the basic exclusion amount will need to enlist the assistance of a qualified team including their certified public accountant, estate attorney, and financial planner. Together, this team can advise them of their options and the pros and cons of each approach.
Options that typically will be considered include setting up trusts to hold gifts made to children and grandchildren, spousal lifetime access trusts, annual gifting, and charitable goals.
Further individuals that have ownership interests in family businesses may consider gifting shares of the family business to the next generation as a way to perpetuate the legacy of the business they’ve created. Gifts of business interests can also qualify for gifting discounts when structured appropriately and can be a valuable estate planning tool worthy of consideration.
For families who are interested in planning, it is important to begin the process sooner rather than later. Given the current rules sunset at the end of 2025, there are less than 2 years to determine the best course of action and fully implement it.
While this may be enough time for one family, the teams of professionals helping implement the plan will be doing so for many other families as well. Consequently, families that do not begin soon will likely find that there will not be enough time to implement the plan.
Key Takeaway:
Families need to begin planning soon if they expect to fully implement their plan before the end of 2025.
What If I’m Not Ready To Gift It All Away?
A common concern for many families whose net worth is in between the current exclusion amount and the post 2026 exclusion amount is that they are not ready to gift all their assets now, yet locking in the current basic exclusion would require that they give all or most of their assets away.
Individuals and families who find themselves in this situation still need to begin the planning process early. While they may not make large enough gifts to lock in the full exclusions, they will need to have a clear plan to minimize their future estate taxes. Families in this position will often consider implementing an annual gifting cadence paired with strategic or partial gifts and increased charitable contributions to reduce the amount of their future estate.
Annual Gifting: While the unified lifetime gift and estate tax considers gifts during life, there is an exception for gifts under a specific threshold amount each year. This threshold is called the annual gifting exclusion, and for 2024 the annual gifting exclusion is $18,000 per person.
This means that each individual can give $18,000 to as many individuals as they choose without impacting their lifetime basic exclusion amount. Therefore, a married couple can give $36,000 to each of their children, children’s spouses, grandchildren, and so on each year.
To clarify, see the following illustration:
For large families, this can easily add up. For example, a family with 3 married children who each have three children of their own would have 15 individuals who can receive gifts (3 children + 3 in-laws + 9 grandchildren). If the parents of this family made the maximum annual exclusion gifts, they would be able to pass $540,000 (15 x $36,000) of their assets to future generations each year without impacting their lifetime basic exclusion amount.
Strategic Payments for Tuition or Medical Expenses: There is also an exception to the unified lifetime gift and estate tax for amounts paid directly to an educational institution for tuition or to a health care provider for medical care.
To qualify, the funds must be for tuition or medical care and payment must be made directly to the educational institution or the medical care provider. Gifts to an individual who then uses the funds for tuition or medical care do not qualify for this exception.
Accordingly, families could choose to pay the tuition or medical costs for adult children or grandchildren as a way to efficiently reduce assets that would otherwise be part of their taxable estate while still benefiting the next generation.
Partial Gift: Often individuals will combine an annual gifting plan as discussed above with a large partial gift. With a large partial gift, they make a substantial gift of assets and use up a portion of their basic exclusion amount but retain enough assets to fund their lifestyle going forward.
The first goal with a partial gift is to remove any future appreciation of the gifted assets from the family’s estate and, secondly, reduce their net worth to the point that annual exclusion gifting can hold the growth of the remaining estate in check.
Charitable Giving: Families who are charitably inclined can use charitable giving as an effective tool for controlling the estate taxes they pay. Gifts to charity are exempt from gift or estate taxes. Thus, families who are charitable can simply choose to leave all assets in excess of the basic exclusion amount to charity and avoid gift and estate taxes altogether.
Other families who want to leave most of their assets to their children but are open to some level of charitable giving can use charitable gifts to manage the growth of their estate and create a long-term legacy for the causes they are passionate about in a tax-advantaged way. When both the income and estate tax savings are considered, the benefits of charitable giving for those who expect to have taxable estates are significant.
Key Takeaway:
Families who choose not to lock in the full estate exclusions still have extremely valuable tools for reducing their estate taxes. The key is planning now since strategies like annual gifting become more valuable with time.
Conclusion:
While current gift and estate exclusions are high, they are scheduled to sunset at the end of 2025. This change will have a major impact for many families and provides an opportunity for individuals to engage in planning now that can potentially save millions of dollars for themselves and their families in the future.
Although some individuals have easier decisions than others based on their own facts and circumstances, planning will be important for everyone who expects to have a taxable estate in the future.
For individuals who are not able to take the leap and make large enough gifts to lock in the current exclusion amounts, a coordinated plan around annual giving, strategic gifts, and charitable contributions can still make a significant difference in the amount of gift and estate taxes they and their families will pay.
Individuals, like John, who look back over the years at the sacrifices they made to build successful businesses and careers now have the opportunity to look forward and implement planning that will protect the wealth they’ve created for the next generation and ensure they are able to leave the legacy they worked so hard to create.
If you are interested in connecting with a Family CFO to review your financial picture and determine whether additional planning and coordination with attorneys and other professionals is necessary prior to the sunset of current gift and estate tax provisions, we would love to connect to see if what we do is right for you.
