The federal estate tax exemption is a crucial concept for individuals with a significant estate, but its current high threshold may be slashed by half on Jan. 1, 2026, pending action by Congress. This article aims to demystify the estate and gift tax exemption, explain its impending change, and highlight the potential consequences of inaction for those who might be impacted.
Understanding the Exemption
The federal estate and gift tax exemption allows individuals to transfer a certain amount of wealth to their beneficiaries tax-free during their life or at their passing. This exemption currently sits at a historically high $13.61 million for 2024, nearly double the pre-Tax Cuts and Jobs Act (TCJA) levels (prior to 2018, when the TCJA was enacted). However, this generous exemption is scheduled to “sunset” at the end of 2025, potentially reverting back to around $7 million (adjusted for inflation). This significant decrease presents a unique situation for high-net-worth individuals and families, meaning a reduced amount that individuals can pass on tax-free.
The Looming Impact
If Congress does not take action to adjust the sunsetting provision, the estate tax will reach a much larger group of individuals in 2026 and beyond. This could result in a substantial estate tax burden for those who haven’t planned adequately. While the tax only applies to estates exceeding the exemption amount, the marginal tax rate is steep, at 40 percent. This can significantly erode the value of an estate and leave beneficiaries with less than intended.
It is also important to note that individual assets might also be subject to a state estate tax, even if those assets are not worth the current federal estate tax filing limit of $13.61 million. Current states with an estate tax include Connecticut, Hawaii, Illinois, Maine, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont and Washington, as well as the District of Columbia. Current states with an inheritance tax include Iowa, Kentucky, Nebraska, New Jersey and Pennsylvania. The state of Maryland currently has both an estate tax and an inheritance tax.
Taking Action: Why Proactive Planning Matters
Given the potential consequences of inaction, proactive planning is crucial for individuals with estates exceeding the anticipated post-2025 exemption, or even those below that threshold if their net worth continues to grow. Here’s why:
- Maximize the use of the current exemption: By taking advantage of the current high exemption before its sunset after 2025, individuals can shield a greater portion of their estate from taxation. This can be achieved through various estate and gift planning strategies.
- Reduce the tax burden on beneficiaries: By proactively planning, individuals can minimize the tax liability their estates will face, allowing them to pass on a larger share of the estate to their beneficiaries.
- Peace of mind and control: Taking charge of estate planning offers peace of mind by ensuring your wishes are documented and your assets are distributed as intended. It also allows you to potentially maintain some control over your assets and potentially limit the impact of future tax law changes.
Seek the Help of a Qualified Tax Advisor
While it’s important to act before the sunset, it’s crucial to remember that estate and gift tax planning involve complexities. Professional guidance from a qualified team of advisors, including a financial advisor and estate planning attorney, is essential to understand your specific situation and develop a personalized strategy. Keep in mind that different strategies do exist to utilize the exemption, including lifetime gifting, trusts and charitable giving. Each option has advantages and disadvantages, requiring careful evaluation based on individual circumstances. However, time is of the essence – the closer it gets to the sunset date, the complexity of planning may increase. Starting the process early allows for a more thorough and strategic approach.
Windham Brannon Knows Estate Planning
The impending sunset of the federal estate tax exemption presents both a challenge and an opportunity. By understanding the implications and taking proactive steps, individuals with potentially taxable estates can protect their assets and ensure their wealth is transferred efficiently to their chosen beneficiaries. That’s why seeking professional guidance and starting the planning process early are critical steps toward achieving successful estate planning and minimizing the impact of future tax changes. Windham Brannon’s High Net Worth Practice has extensive experience helping individuals minimize their estate tax burden, providing tax-efficient strategies that help you preserve legacy and wealth for a brighter future for generations to come. We look at your tax situation holistically for a complete solution, knowing when to involve help from experienced attorneys for more complex gift strategies – we can work alongside your current attorney or make introductions to attorneys we trust. For more information on the estate and gift tax exemption and its impact to your own estate, reach out to your Windham Brannon advisor today, or contact Doug Neal.
Source:
Yushkov, Andrey. Does Your State Have an Estate or Inheritance Tax? Tax Foundation. Oct. 10, 2023.
