Everyone loves a good sunset. However, there is one sunset that is coming at the end of 2025 that won’t be as welcome. We are referring to the sunsetting of the current federal estate tax exemption amounts to 2017.
This looming sunset is a reminder that it’s crucial for individuals and business owners to review their estate planning strategies. This change has significant implications for how your estate is managed after your passing and can profoundly affect the legacy you leave behind.
One key frame that is important when thinking about the Estate Tax and how it applies to your personal planning. It is imperative to remember that you are not planning for your current situation, but rather for what your estate will look like in the future. With that, let’s dive into the topic.
Understanding Estate Tax and Its Implications
The estate tax is a tax levied on the net value of the estate of a deceased person before distribution to the heirs. The federal estate tax exemption allows a certain amount of an estate to pass to heirs without incurring federal estate taxes. For 2024, the exemption level stands at $12.92 million per individual and $25.84 million for a married couple.
However, unless Congress takes action, these levels are set to revert to approximately $5 million per individual, adjusted for inflation, at the end of 2025. With the current estate tax of approximately 40% on every dollar over the threshold, this reduction could mean a substantial tax burden for estates exceeding the new threshold.
The conventional wisdom, including among those on Capitol Hill, is that given the current amount of gridlock in our national politics, it seems highly unlikely that Congress will in fact do anything to preserve the current exemption levels, so planning should be done now to avoid an unwanted tax bill.
Furthermore, the IRS confirmed that planning done now will not be adversely affected by the resetting of the exemption limits. Per the IRS website, “On November 26, 2019, the IRS clarified that individuals taking advantage of the increased gift tax exclusion amount in effect from 2018 to 2025 will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop to pre-2018 levels.”
The Importance of Estate Liquidity
There are two big and related wrinkles when it comes to the estate tax. Generally, an estate tax filing, and related estate tax payment, are required within nine months of the date of death. And that payment – it needs to be made in cash. This means that an estate needs access to liquidity in a relatively short period of time and usually without much advanced warning.
Ensuring there is enough liquidity in the estate to cover estate taxes and other expenses without needing to sell significant assets or a business poses a big challenge. Without proper planning, your estate may be forced to sell assets (including your business) that you did not want sold or at valuations that are less than ideal. Plus, the cash required to pay these liabilities take away from the legacy you intended to leave to your beneficiaries, including heirs and charitable organizations.
What Can Be Done?
With proper planning, there are strategies that can be implemented to both help reduce overall potential exposure to the estate tax and to ensure there is adequate liquidity available to pay any liabilities without selling assets or diminishing inheritances.
For example, gifting assets during your lifetime can reduce the size of your estate and, consequently, the estate taxes due upon your death. Utilizing the annual and lifetime gift tax exclusions and making strategic gifts can help lower your estate’s value and provide liquidity to your heirs.
To ensure your estate has the cash needed at your death, life insurance can provide the necessary liquidity to cover estate taxes, debts, and other expenses. The death benefit from a life insurance policy is generally income tax-free and can be used to pay estate taxes, thus preserving the value of your assets and business for your heirs.
Combine those two concepts and you have a strategy to both lower your potential estate tax exposure and have liquidity to pay any liabilities. Here’s how:
- Using the lifetime gift exclusion, you gift taxable assets to an Irrevocable Life Insurance Trust (“ILIT”). This takes those assets out of your estate (and therefore they no longer count against your exclusion or will become subject to estate taxation).
- The trustee of the ILIT purchases a life insurance policy on your life. When you die, the proceeds of the policy will go to the ILIT, not your estate, and do not count towards the estate’s value, thus reducing estate tax liability.
- The ILIT distributes the proceeds to your beneficiaries (per the terms of the ILIT), providing liquidity to pay any potential liabilities, or as an inheritance.
This is one example of how timely planning can help to both mitigate potential estate taxes as well as provide potentially necessary liquidity.
The Golden Era Is Ending
With the current federal estate tax exemption level and strategies available, we live in what many consider to be the golden era of estate planning. However, with the looming sunset of that exemption level, this era may be nearing an end.
At Transcend Advisor Group, we work with you to understand your current situation as well as where you want to go. Using decades of tax expertise, we work to ensure that every part of your plan – every investment, insurance policy, and recommendation – is optimized for tax efficiency. That applies to potential estate tax liabilities as well.
If you fear your estate may be subject to estate taxation and would like to explore your options to mitigate these potential taxes and ensure your estate has sufficient liquidity to pay any liabilities, reach out.
