The Estate Tax Exemption Sunset is Just Over the Horizon

By: BPE Law Group, PC

Zack Sabbagh

July 24, 2023

What is the Estate Tax?
An estate tax is the Federal Government’s way to tax your estate’s assets when you die. The estate tax has been significantly avoided by most people for the last decade, primarily through smart and proactive estate planning.

First, I should explain how the Estate Tax works. The Estate Tax is a tax levied onto an individual’s estate upon that individual’s death. The current Estate Tax rate is 40%. However, an estate is only taxed if the estate’s value exceeds the set exemption amount.

For example, say your current estate is valued at $6 million dollars and we use the exemption amount from 2016, being $5.45 million per individual. In this scenario, your estate would be subject to an estate tax for amounts exceeding the $5.45 million exemption. Therefore, $550,000 would be subject to the Estate Tax and would be taxed by 40%, giving the United States government $220,000 upon your death. That is money that could have gone to your children, grandchildren, siblings, or significant others.

Since the passing of the Tax Cuts and Jobs Act (TCJA) in 2017, the Estate Tax exemption amount has increased to $12.92 million per individual and is indexed for inflation. The actual Estate Tax percentage is still set at 40% but now an individual needs to exceed $12.92 million in their estate to even be subject to the tax. So, if you, and your spouse, have assets valued less than $25.84 million, then your estate will not be subject to Estate Tax if you die before December 31, 2025.

Sunset of Estate Tax Exemption
Now $12.92 million may seem like a large number and therefore one may simply shrug that off and continue to delay a meeting with an estate planning attorney. However, the TCJA is set to “sunset” or expire at the end of 2025. What does that mean? Starting in 2026, the Estate and Gift Tax exemptions will no longer be at the increased $12.92 million value set by the TCJA. Rather, the Estate Tax exemption amount will revert to its pre-2018 value of around $5.45 million. With the exemption drastically being reduced, individual’s estates will more easily be subjected to a 40% estate tax upon their death.

What Does the Sunset Mean for You?
Congress may vote to continue the increased exemption amount, but with today’s uncertainty, it is not guaranteed that Congress will act in that manner. To avoid risks that the future holds, creating an estate plan before the TCJA “sunsets” will lock in an individual’s estate and gift tax exemptions through so-called “anti-clawback.” As described by the IRS, an estate that has already properly planned their estate will have their exemption amount locked in. Therefore, their effective exemption amount will not decrease when, for example, the exemption drops back down to approximately $5 million in 2026.

The IRS’s ruling allows proactive individuals to safeguard their estates from being subject to lower exemption amounts at the start of 2026. For individuals with a surviving spouse, you can also transfer the remaining exemption amount to your spouse who can then use your remaining exemption amount in addition to their own. This would further secure a family’s, and business’s, assets through effective estate planning.

However, there are some exceptions that apply especially in the world of the Gift Tax. So, it is always best to discuss with an estate planning professional how you can properly plan your estate.

How to Avoid Estate Tax
One workaround, for those with estates over the exemption amount, was to instead gift away large amount of their estate’s value before they deceased. As clever as that was, the IRS caught on to this tactic in 1924. The IRS created a uniform tax credit so that both the Estate Tax exemption and the Gift Tax exemption share the same lifetime exclusion. This means that whenever you give a gift over the yearly dictated gift exemption amount set by the IRS, that gift will also reduce your estate exemption amount equally.

Maybe an example will better explain this. An individual is on his deathbed and has $14 million in his estate. To prevent a 40% estate tax on his approximately $1.8 million that is over the exemption amount, this individual gives away that money to his children, friends, parents, and siblings. Before 1924, this would have worked in preventing an estate tax from being levied onto this individual’s estate. Now, gifts will decrease the individual’s overall estate tax exemption amount. So, with that $1.8 million gift this individual gave, his estate tax exemption would be reduced accordingly to $11.12 million. Anything over that amount will now be taxed at 40%.

Yet, the IRS does not want to prevent individuals from giving gifts. So, the IRS has allowed individuals to gift up to $17,000 per person per year without that amount affecting their estate or gift tax exemption amount. This gives great flexibility for one’s estate planning, especially if done early enough to take advantage of such yearly exemptions.

Meet with an Estate Planning Professional
It would be a gamble to wait and see what Congress will do as we rapidly approach the end of this generous estate and gift tax exemption amount. The best thing to do would be to seek professional help to assist in planning your estate. Each estate is unique and it would be in your best interest to discuss with an attorney what specific needs your estate requires. The sooner you plan your estate, the better one can prepare for the future.

The information presented in this Article is not to be taken as legal advice. Every person’s situation is different. If you are facing a legal issue of any kind, get competent legal advice in your State immediately so that you can determine your best options.


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