Key Takeaways:
- Utilizing current tax exemptions through strategic gifting and trusts can significantly reduce future tax burdens, making it essential to act promptly and consult with an estate planning advisor.
- The current elevated estate, gift, and GST tax exemptions, set to revert to lower levels on December 31, 2025, necessitate proactive estate planning to avoid increased tax liabilities.
- High-net-worth individuals could face substantial estate taxes if they do not adjust their estate plans before the exemptions decrease, making it crucial to consider strategic lifetime planning and gifting now.
The Time to Plan is Now
As the end of 2025 approaches, individuals and families with significant assets need to consider the implications of the scheduled expiration of the higher federal estate tax exemption. Currently, the Tax Cuts and Jobs Act (TCJA) of 2017 has temporarily doubled the estate, gift and generation-skipping transfer (GST) tax exemptions. For 2024, the exemption amount is $13.61 million per individual.
However, on December 31, 2025, these increased exemptions are set to revert to their pre-TCJA levels, which are approximately half of the current amounts. This impending change underscores the importance of lifetime planning and strategic gifting to minimize federal estate taxes.
The impact on high-net-worth individuals – and their heirs – could be massive if nothing is done to plan and realign an estate plan in preparation for the change. A married couple today has a combined federal estate plan exemption of $27.22 million ($13.61 million per individual). That means any estate value above those amounts would be taxed after the owner’s death at rates from 18% up to 40%, depending on the size of the estate.
However, when the TCJA exemptions expire, those exemptions will be cut roughly in half. Estates that have grown in value may be liable for significant estate taxes if the owners don’t start planning now. By not taking opportunities that exist today to do lifetime planning and gifting, you could be exposing your estate to a major tax liability.
By taking advantage of tools such as lifetime transfers of assets, trusts and gifting, estate owners can manage their assets to allow the assets to continue growing in value, while avoiding estate taxes upon the owner’s death. The more assets you move out of your estate while you’re still alive, the better off your estate and your heirs will be.
The Importance of Lifetime Planning
Lifetime planning involves making strategic financial decisions during one’s life to manage and protect wealth for future generations. Effective lifetime planning can significantly reduce the estate tax burden on heirs. Key strategies include:
- Gifting: One of the most effective ways to reduce the size of an estate and minimize estate taxes is through lifetime gifting. The IRS allows individuals to gift a certain amount annually to any number of recipients without incurring gift taxes. For 2024, this annual exclusion amount is $18,000 per recipient. Additionally, individuals can use their lifetime gift tax exemption to make larger gifts. By taking advantage of these provisions, individuals can transfer wealth to their heirs during their lifetime, thereby reducing the value of their taxable estate.
- Trusts: Trusts are powerful tools in estate planning. Irrevocable trusts, in particular, can remove assets from the grantor’s estate, reducing the estate’s value for tax purposes. Various types of trusts, such as Intentionally Defective Grantor Trusts (IDGTs), Grantor Retained Annuity Trusts (GRATs), Charitable Remainder Trusts (CRTs) and Irrevocable Life Insurance Trusts (ILITs) can be utilized to achieve specific estate planning goals while minimizing tax liabilities.
- Family Limited Partnerships (FLPs): FLPs allow families to pool assets and transfer them to younger generations at discounted values due to lack of marketability and minority interest discounts. This strategy not only helps in managing and preserving family wealth but also in reducing the overall taxable estate.
- Valuation discounts: When transferring interests in family-owned businesses or properties, valuation discounts can be applied for lack of control and marketability, effectively reducing the value of the transferred assets for gift and estate tax purposes.
For business owners, gifting an LLC interest to the owner’s partners can have the effect of reducing the size of the owner’s estate. The first step is to get a valuation done of the business, which builds in certain discounts because an LLC interest is different from the underlying assets. For instance, if a single partner’s interest in an LLC is valued at $1 million and the owner gifts that entire interest to other partners, the owner is gifting the LLC interest, not the underlying asset. Because there’s no transferability, a 25% to 30% discount would be applied, immediately moving approximately $700,000 out of the owner’s estate.
Many business owners and high net worth individuals are currently realigning their estate plans by transferring assets to trusts, transferring stock, transferring LLC interests and gifting direct assets such as premiums on life insurance policies.
This is all in preparation for the 2025 change in the federal estate tax exemption. When the TCJA was enacted in 2017, many provisions – including the increased estate tax exemption – were scheduled to expire at the end of 2025. This enabled millions of Americans to sit back and watch as the phenomenal increases in real estate values, business values and stock market assets ballooned their estate values up to – and beyond – the current exemption amounts.
But now it’s time to pay the piper, and there’s no time to waste.
Strategic Gifting Before the Exemption Decreases
With the higher exemption amounts currently in place, there is a unique opportunity to make substantial gifts before the exemption reverts to lower levels. Utilizing the current exemption can involve:
- Making large lifetime gifts: Individuals can gift assets up to the current exemption amount without incurring gift taxes. This strategy is particularly beneficial for those with estates that will likely exceed the lower exemption amounts after 2025. Making these gifts now ensures that they are shielded from estate taxes even if the exemption decreases in the future.
- Spousal Lifetime Access Trusts (SLATs): A SLAT is an irrevocable trust where one spouse makes a gift into a trust for the benefit of the other spouse. This allows the donor spouse to utilize their lifetime gift exemption while still indirectly benefiting from the trust assets, as the beneficiary spouse can access the trust assets if needed.
- Dynasty trusts: These are long-term trusts designed to pass wealth down through multiple generations without incurring additional estate or GST taxes. Funding a dynasty trust now with assets up to the current exemption amount can provide significant tax savings for future generations.
Considerations and Risks
While lifetime gifting and planning offer substantial tax advantages, they also come with considerations and risks:
- Loss of control: When assets are gifted or placed in certain types of trusts, the donor relinquishes control over them. It is essential to balance tax savings with the need for control and access to assets.
- Asset performance: The future performance of gifted assets can impact the overall effectiveness of the gifting strategy. If gifted assets appreciate significantly, the tax savings can be substantial. However, if they underperform, the donor might have been better off retaining the assets.
- Legislative changes: Tax laws can change, and future legislation could impact the effectiveness of current planning strategies. It is still possible that Congress could act to make the current estate plan exemptions permanent, or to extend them several more years. But given that we are in a contentious presidential election year and the priorities of a new Congress and possibly a new administration in 2025 may or may not include estate tax law, taxpayers are better off being cautious and preparing themselves for the change we know is on the horizon.
In Summary
The impending sunset of the TCJA exemptions presents both a challenge and an opportunity for estate planning. Thoughtful planning now can result in significant tax savings and peace of mind for the future. The current elevated exemption amounts offer a unique opportunity to transfer wealth tax-free, but the window to act is closing.
If you would like to discuss making changes in your estate plan, contact your KRD estate planning advisor.
