Estate Tax Exemption – Use it Now!

October 13, 2020

Federal tax law levies a tax on the value of assets you own at death.  The estate tax is levied at a 40% rate and can severely impact the transfer of wealth to future generations.  Many business owners are simply unaware that the value of their business exposes them to the tax and that may prevent the business from being passed on to future generations.

Gift Tax

Federal law also imposes a tax on lifetime gifts in order to “protect” the estate tax.  Otherwise, deathbed transfers could be made to reduce a decedent’s estate below the taxable threshold.  Think of gift taxes as applying to gratuitous transfers made during life and estate taxes levied on such transfers at death.  Each person has just one exemption for gratuitous transfers made either during life or at death.  So, what is the most efficient way to use the exemption?  The answer may surprise you.

The good news is that every person has a pretty large exemption from gift or estate taxes.  In 2020, the exemption amount is $11.58 million.  That amount is adjusted each year by an inflation factor.  The 2017 Tax Cuts and Jobs Act essentially doubled the exemption and such increase will expire on January 1, 2026, unless Congress extends the higher exemption.

Most people wait until death to use their exemption.  Lifetime use of the estate and gift tax exemption is optimal for the following reasons:

Transfers at Death are Tax Inclusive

At death, transfers to heirs are tax inclusive.  Transfers to heirs carry with them the burden of the federal and state estate taxes levied on the estate.

Lifetime Transfers are Tax Exclusive

Transfers to gift recipients are tax exclusive since the person making the gift pays any gift tax and generally, states do not levy gift taxes.  The exceptions are Connecticut’s gift tax and states like Illinois and Vermont that pull lifetime gifts back into the state estate tax equation.  Other states may pull gifted assets back into the state estate tax calculation.

Growth Escapes Taxation

Large gifts require the use of a portion of a person’s exemption amount.  However, the growth of gifted assets escapes future estate taxation.

Exemption Amount Could be Reduced

Using the new, high federal exemption now may prove critically important if it reverts back to the previous, lower amount.  In addition, a new administration could move to expose more estates to the estate tax. 

Preferred Strategies – Gone?

Several trust techniques are available to facilitate the utilization of the exemption amount.  Some are designed to make trust assets available to the transferor.  Grantor trusts, grantor retained annuity trusts, and spousal lifetime access trusts, to name a few, are currently available techniques.  These very favorable strategies could be legislated out of existence.

Preparing a detailed retirement cash flow plan will help determine a person’s financial flexibility to implement irrevocable, tax-saving strategies.  Caution is advised since many states levy their own estate taxes using rules different than federal law.  So, consulting with an estate planning attorney before implementing any strategy is critical.

Taking action in 2020 to protect family wealth from federal and state estate taxes is critical given the potential for the expiration of the higher exemption.  Remember, using the exemption early is most efficient!

No representation is being made that any strategy shown will or is likely to achieve results similar to those shown in this presentation. BDF does not provide legal, tax, insurance, social security or accounting advice. Clients of BDF should obtain their own independent tax, insurance and legal advice based on their particular circumstances. The information herein is provided solely to educate on a variety of topics, including wealth planning, tax considerations, insurance, estate, gift and philanthropic planning. See additional disclosures.