An opportunity to avoid an increase in estate taxes
President Biden recently revealed his 2024 budget bill. Not surprisingly, a lot of changes are being proposed to the taxes we pay, especially for the wealthy. Proposals in the budget include limiting the “step up in basis” for assets passed upon death, increased tax rates for the wealthy, and other increases. Seems like everyone is happy raising taxes other people pay, but no one wants to see their own tax bill go up. When it comes to estate tax rates, or taxes on the money you leave behind for your heirs, that debate also rages on.
For years, Republicans have continued to attack the “death tax” as unfair and punitive, particularly as applied to family farms and small businesses. Legislation enacted in 2017 resulting in increasing the exemption on individual estates to over $11 million per person. The size of an estate that is now exempt from federal estate taxes in 2023 for U.S citizens is now $11,920,000. This amount increases with inflation adjustments annually under the present law for 2024 and 2025. The current rate at which amounts over the exemption are taxed is 40%, meaning that every additional million dollars over the exemption will generate a $400,000 tax bill.
The good news for 99.8% of Americans is that with such a large exemption, estate taxes are no longer a concern. But will it last? As has often been said, nothing is safe while the legislature is in session. But we do know that if nothing is done, the current exemptions expire at the end of 2025, so the rate if nothing happens will be reduced back to the old rate, adjusted for inflation up through 2025, and will probably land somewhere around $7 million per person (economics is not my thing, so don’t expect any predictions on inflation here).
For those couples with assets more than $15 million, the current tax exemptions create a planning opportunity for using large exemptions before they get reduced. Wealthy individuals can create trusts known commonly as SLATs, spousal lifetime access trusts, and use up their exemptions before they get reduced. The basic strategy is to divide a couple’s assets into two separate property piles, one for each spouse. The spouses then gift their respective separate property halves into trusts for each other and/or other beneficiaries, which uses up the current exemptions before they get reduced. These trusts must be carefully drafted to survive attack by the IRS, particularly avoiding creating trusts which look too much alike, which would violate something known as the reciprocal trust doctrine, the destroyer of these trust benefits.
For example, if we assume that with the inflation adjustments for the next few years results in an exemption of $12,500,000 for 2025, but that number goes to only $6,250,000 in 2026, a couple successfully employing this strategy with assets of $25,000,000 would remove $12,500,000 from possible estate taxation, which at the current rate of 40%, would result in a tax savings for heirs of $5 million dollars. In addition, the assets placed in these trusts would continue to grow estate tax free, resulting in even more tax savings.
What will finally (if there is ever truly a “finally”) come of this? Hard to say. But what this does mean is that planning for the likely reduction in estate exemptions after 2025 creates a great planning opportunity for those with estates that are likely to see an increase in the estate taxes that will be payable upon their deaths due to the reduction in the exemptions scheduled to take effect in 2026. If you believe you fit into this category, you should seek guidance from an experienced estate planner to see if this opportunity makes sense for your family.
By Michael G. Carroll