Donate your estate now to reduce your tax exposure later

The federal estate tax exemption helps wealthy families avoid or reduce estate taxes, but time is running out on the magnitude of this benefit.

In 26 months, some families who pay no estate tax today may face significant federal taxes unless benefactors take action. Even if few families have sufficient assets to be affected, the percentage likely to pay inheritance tax due to the reduction in the exemption could more than double.

The current exemption limit is $12.92 million for individual estates and $25.84 million for combined estates of married couples. Congress set this limit, adjusted for inflation, in 2017, doubling the existing exemption.

However, that legislation included a sunset provision calling for the exemption to return to pre-2018 exemption amounts on 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 people. couples.

This reduction would expose some estates to federal tax for the first time in years and others for the first time ever. About 0.1% to 0.2% 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 0.3-0.4%.

The new families affected would include those who are much less wealthy.

For example, the heirs of an estate containing only a large house, a vacation home and a few million in cash could be liable for inheritance taxes that they would not face today. Non-exempt portions of estates are currently subject to a progressive tax that caps at approximately 40% on values ​​of $1 million or more.

Making changes to estate plans can be time consuming. It is therefore essential that do-gooders start considering changes as soon as possible. A common strategy is to reduce the value of your estate before December 31, 2025, and then keep it below the exemption limit, if possible, or as low as possible to minimize tax exposure.

One way to do this is to gift heirs with cash or other valuable items – investment securities, art collections, jewelry, etc. – each year.

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

As this is an annual cap, benefactors can take advantage of it by making donations in 2023, 2024 and 2025. This annual tax exclusion cap for donations does not change, so you can continue to make these donations after 2025.

Although gifts above the limit may not trigger any taxes directly, this additional value would count toward what is known as your lifetime estate and gift tax exemption – the sum of all non-excluded value that you gave during your entire life plus the value of your estate at your death.

This cumulative personal total is the IRS’s way of limiting the amount taxpayers can legally give to protect their estate from taxes. Because gifts in excess of the exclusion limit add to your lifetime exemption total, making gifts beyond the size of your estate may be counterproductive.

Unless you have a substantial exemption margin over your lifetime, it may be a good practice to keep gifts below the $17,000 exclusion limit.

There are various other ways to pass part of your estate to your heirs during your lifetime, before the current exemption is reduced by half. Among them are:

• Create and fund 529 college savings plans for young parents like grandchildren, great-nephews and nieces. Funds withdrawn from these plans are tax-free when used to pay for K-12 and college education expenses. Current rules allow initial funding over five years of the gift exclusion amount of $17,000 for individuals and $34,000 for married couples. For example, a married couple with 10 grandchildren could start a 529 plan for each grandchild and initially fund each account with a maximum of $170,000. This would ensure substantial resources for their grandchildren’s education while reducing the couple’s combined estate by up to $1.7 million. These gifts would not count toward the couple’s lifetime exemption because they fall within the exclusion limit.

• Create and fund 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. These trusts are irrevocable, meaning the terms of the trust, including the beneficiary, cannot be overturned in the event of divorce or separation. So, undertaking a SLAT requires trust in a marriage. Some couples arrange a SLAT for each spouse, essentially sharing control of their joint assets after removing them from their combined estate.

• Creating a QPRT — Qualified Personal Residence Trust. These trusts involve transferring your home to an heir while continuing to live there for the duration of the trust. The value of the house immediately emerges from the estate. At the end of the trust term, the home becomes the property of the heir, usually an adult child, so entering into these trusts requires a trust in filial relationships. To get the expected benefit, you must outlive the term of the trust. If you don’t do this, the house reverts to your estate, which defeats the purpose of the QPRT, so your age and health may be taken into account.

• Transfer life insurance policies out of your estate. Having a policy in your name can automatically make it part of your estate, and a substantial policy can significantly increase the total value of your estate. The solution is to transfer the property 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.

While arranging to reduce the value of your estate through donations, it’s a good idea to update real estate appraisals. Significant increases in property values, common in many parts of the country over the past two years, may bring the value of your estate closer to the intended exemption limit than you think.

These appraisals would be helpful when selling a property to raise money for gifts or for funding trusts and 529 plans.

Such moves can involve various complexities, 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.

By planning carefully and working with expert advisors, you will be able to make informed choices about how to manage the anticipated exemption reduction and ensure that more of your wealth goes to your loved ones.

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

Correction: This article has been updated with the correct terminology for a trust to donate a residence.