Donate from your estate now to reduce your tax burden later

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The federal estate tax exemption helps wealthy families avoid or reduce estate taxes, but the clock is ticking on the size of this benefit.

In 26 months, some families who don’t pay estate taxes today face significant federal taxes unless benefactors act. Although few families have enough wealth to be affected, the percentage expected to pay inheritance tax due to the reduced tax exemption may more than double.

The current exemption limit is $12.92 million for the estate of individuals and $25.84 million for the entire estate of married couples. Congress established this inflation-adjusted limit in 2017, doubling the existing exemption.

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However, that legislation included an expiration provision that provided that the exemption would revert to pre-2018 exemption amounts beginning January 1, 2026. Unless Congress intervenes, the exemption will then be cut in half – to less than $7 million for individuals and about $13 million for married couples.

This reduction would make some properties subject to federal taxes for the first time in years and others for the first time ever. About 0.1 to 0.2 percent of the estates of people who died in recent years were subject to federal tax. Under the planned lower exemption, this range could increase to 0.3 to 0.4%.

The new families that would be affected included those with far fewer assets.

For example, heirs to estates that include no more than a large house, a vacation home, and a few million in liquid assets could owe inheritance tax that they would not have to pay today. Non-exempt portions of estates are currently subject to a progressive tax, which is approximately 40% on values ​​of $1 million or more.

Do this as quickly as possible

Making changes to estate plans can be time-consuming. Therefore, it is important for donors to think about changes as quickly as possible. A common strategy is to reduce the value of your estate before December 31, 2025 and then, if possible, keep it below the exemption limit or as low as possible to minimize the tax burden.

One way to achieve this is to give heirs annual gifts of cash or other valuables – securities, art collections, jewelry, etc.

There is no tax on annual gifts valued at less than $17,000 per recipient for individuals and $34,000 for married couples. And the number of recipients is unlimited.

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Because this is an annual limit, patrons can take advantage of it by making gifts in 2023, 2024, and 2025. This annual gift tax exclusion limit does not change, so you can continue to make these gifts after 2025.

Even though gifts over the limit may not trigger a direct tax, this additional value counts toward what is known as the lifetime estate and gift tax exemption – the sum of all non-excluded value you donated over your lifetime, plus the value of your gift estate, if They die.

With this running personal total, the IRS limits how much taxpayers can legally donate to protect their assets from taxation. Because gifts in excess of the exclusion limit increase your lifetime exemption amount, reducing the size of your estate as a result may prove self-defeating.

Unless your lifetime allowance has significant wiggle room, it may be a best practice to keep gifts under the $17,000 exclusion limit.

Consider these other steps too

There are several other ways to pass parts of your estate to heirs during your lifetime before the current tax exemption is halved. Among them are:

  • Creating and funding 529 college savings plans for young relatives such as grandchildren, great-nephews and nieces. Funds withdrawn from these plans are tax-free when used to pay educational costs for grades K-12 and college. Current rules allow upfront funding with a five-year gift exclusion of $17,000 for individuals and $34,000 for married couples. For example, a couple with 10 grandchildren could set up a 529 plan for each grandchild and initially fund each account with up to $170,000. This would secure significant funds for their grandchildren’s education while reducing the couple’s total assets by $1.7 million. These gifts would not count toward the couple’s lifetime exemption because they are within the exclusion limit.
  • Establishing and funding a Spousal Lifetime Access Trust (SLAT) to transfer significant amounts of your marital assets to your spouse, who would then have sole control of those assets. Such trusts are irrevocable, meaning that the terms of the trust, including the beneficiary, cannot be reversed in the event of a divorce or separation. So conducting a SLAT requires trust in a marriage. Some couples agree to a SLAT for each spouse, essentially sharing joint control of their joint assets after they move out of the joint estate.

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  • Creating a QTIP – Qualified Cancellable Real Estate Trust. These trusts involve gifting your home to an heir but continuing to live in it for the duration of the trust. The value of the house is immediately determined by the estate. At the end of the trust term, the home becomes the property of the heir, usually an adult child. Therefore, entering into these trusts requires trust in the child’s relationships. To receive the intended benefit, you must outlive the term of the trust. If you don’t, the house will revert back to your estate, defeating the purpose of the QTIP, so your age and health may play a role.
  • Transferring life insurance policies from your estate. If you have a policy in your name, it can automatically become part of your estate, and a comprehensive policy can significantly increase the overall value of your estate. The solution is to transfer ownership to an heir or, to reduce the heir’s tax liability, to an appropriate form of trust, with that heir as the beneficiary of the trust.

Are you close to the limit?

As you prepare to lower the value of your property through gifts, it’s a good idea to get current property appraisals. Significant increases in property values, which have been common in many parts of the country in recent years, can bring the value of your property closer to the planned exemption limit than you might think.

These appraisals can be useful when selling real estate, raising money for gifts, or funding trust funds and 529 plans.

Such steps can vary in complexity, so it’s a good idea to consult an estate planner, financial advisor or tax professional who is familiar with federal tax rules and inheritance taxes in your state.

Through careful planning and working with expert advisors, you can make informed decisions about how to handle the proposed tax exemption reduction and ensure that more of your assets benefit your loved ones.

– By Trey Smith, CFP, Registered Representative, Truist Investment Services and Investment Advisor Representative, Truist Advisory Services

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