Take Action Now: High Estate & Gift Tax Exemptions Could Vanish in 2021
As with any election, there is the potential for significant impact on estate and gift taxes. Under the Tax Cuts and Jobs Act of 2017, the federal exemption from gift and estate tax rose to $11.58 million per person with a tax rate of 40% on the value of assets above that limit. This means that under current law, married couples can leave a $23.16 million inheritance to their children, tax free. However, like all good tax stories, this one does not have a happy ending.
The high federal exemption amount is set to return to a $5 million level, indexed for inflation, at the end of 2025. And a change in administration on election day might not only hasten that reality but also usher in an even lower threshold. A $3.5 million exemption from tax at death and a $1 million gift limitation during life are among some of the tax law changes being discussed. Here’s what that might look like:
Jacob and Ashley have a home, life insurance, and investments valued at $8 million. Under current law, they can leave the entire $8 million to their three children estate-tax-free at death. If the exemption drops to $3.5 million ($7 million for married couples) there would be a tax of $400,000 due to Uncle Sam, with a net result of $7.6 million passing to the children.
$8 million estate
-$7 million exemption
$1 million subject to tax
$1 million
x 40% tax rate
$400,000 tax bill
This doesn’t even consider the estate tax imposed by some states, such as Massachusetts (with its lowly $1 million exemption), which only adds to the overall bill.
There are several irrevocable trust techniques to reduce or even eliminate this undesirable tax. Spousal Lifetime Access TrustsThis irrevocable trust represents a gift usually to the spouse and heirs of the Grantor. Read More (“SLATs”) are often the top choice for married couples. SLATs are a means of reducing the size of the estate today by making an irrevocable gift to a trust for the benefit of a spouse. Assets transferred into a SLAT cannot be taken back but can be “accessed” indirectly through the beneficiary spouse, who is permitted to receive distributions from the trust at any time during his or her lifetime. The funds in an irrevocable trust, such as a SLAT, are not included in the estate tax calculation at death, thereby potentially saving thousands of dollars. Here’s how:
Jacob and Ashley visited an estate attorney and established SLATs for one another in 2020. They placed their home, life insurance, and investments into the trusts. Unlike the result above, if the exemption drops to $3.5 million ($7 million for married couples) there would be $0 estate tax due with a net result of the full $8 million passing to the children.
$0 estate ($8 million transferred to the SLATs does not get included)
-$0 exemption (Jacob and Ashley each used $4 million of exemption in 2020)
$0 subject to tax
$0 subject to tax
x 40% tax rate
$0 tax bill
Regardless of the election outcome, the likelihood of future decreases in the gift and estate tax exemption and increases in tax rates make planning critical, especially given the possibility of policy changes being applied retroactively. With proper planning, SLATs or similar irrevocable trustsA trust that cannot be revoked by the Grantor. Irrevocable trusts are created to either save taxes or protect assets, or both. More can be established now and later undone, within a limited timeframe, to account for a change in circumstances. Legal strategies like SLAT planning require time to execute, both legally and practically, but are quite effective with proven results.
Contact one of our paralegals to discuss this further.
