Guy Hockerman, CPA, CFP®, Financial Planning Manager, Commerce Trust Company
|
Key Highlights
|
The expiration of an existing tax provision is on the way which could greatly increase the number of high-net-worth individuals impacted by the estate tax. In this article, we will explore what the lifetime estate and gift tax exemption is and what changes may be on the horizon. If no new legislation is passed and your estate plan has not been reviewed in anticipation of a reduction to the exemption amounts, these changes could lead to a significantly higher estate tax liability as soon as 2026.
What is the Federal Lifetime Estate and Gift Tax Exemption?
The IRS requires payment of an estate tax if the value of an individual’s estate exceeds a specific dollar amount that includes any taxable gifts that occurred during the decedent’s life. Taxable gifts are recognized when the value of the transferred assets exceeds the annual gift tax exclusion per individual recipient (besides gifts given to a spouse) for the calendar year. For 2024, the annual gift tax exclusion is $18,000. Gifts over that amount to a single person are considered taxable gifts and require filing a Form 709 gift tax return with the IRS.
For the federal lifetime estate and gift tax exemption, the value of any assets over the exemption amount will be subject to estate taxes. Conversely, if the value of transferred assets and lifetime taxable gifts is lower than this threshold, no estate tax would be incurred.
In 2024, the lifetime estate and gift tax exemption amount is $13,610,000 for individuals and is effectively doubled to $27,220,000 for married couples as the IRS allows the transfer of the deceased spousal unused exclusion (DSUE) amount to the surviving spouse. In other words, if the deceased spouse only “used” $13 million of their exemption amount, the remaining $610,000 can be used to increase the exemption available to the surviving spouse by that amount.
It is important to emphasize that the IRS combines the total value of taxable gifts given over someone’s entire life with the total value of their estate (minus permissible deductions) to determine what portion of an estate is tax-exempt. For example, if an unmarried individual’s estate is valued at $10 million and they gave away $5.61 million in total taxable gifts throughout their life, they would be obligated to pay estate tax on the $2 million that exceeds the exemption amount if they died in 2024. Since the top tax rate for the federal estate tax is 40%, the tax due on the value of assets over the exemption amount can be significant.
Figure 1 - Total Value of Estate + Lifetime Taxable Gifts
What Might Change with the Lifetime Estate and Gift Tax Exemption?
The estate tax has a turbulent legislative past. The concept of the modern estate tax was enacted in 1916, but it remains a heavily debated issue among lawmakers with strong opinions regarding fair exemption amounts and even the mere existence of an estate tax. In recent history, the estate tax has remained in place and the lifetime estate and gift tax exemption amount has increased to adjust for inflation every year since 2011.1
The most significant recent change to the exemption amount occurred in 2017 when Congress passed the Tax Cuts and Jobs Act (TCJA), which temporarily doubled the individual exemption amount from $5,490,000 to $11,180,000, as adjusted for inflation.2 Someone with a $10 million estate would have paid taxes on over $4.5 million in assets before the passing of the TCJA, while the same person had no estate tax obligation after the TCJA estate tax provisions took effect.
Since 2018, the exemption amount has increased steadily to keep pace with inflation. The tax reform legislation enacted in 2017 via the TCJA is set to expire (or sunset) in tax year 2026, which would revert the exemption amount to pre-2018 levels as adjusted for inflation unless further legislation is passed. Such a drastic reduction in the lifetime estate and gift tax exemption amount could greatly increase the estate tax liability for high-net-worth individuals.
Notably, the “generation-skipping transfer” (GST) tax exemption would also be reduced by the sunset of the TCJA tax provisions. This exemption is separate from, but functionally similar to, the lifetime estate and gift tax exemption. Taxable gifts given to someone two or more generations below the donor’s generation can be transferred tax-free up to the GST tax exemption amount. Any taxable gifts over this amount would be taxed, which could mean a higher tax liability if the GST tax exemption reverts to pre-TCJA levels.
Figure 2 - Lifetime Estate and Gift Tax Exemption Amount
How Do You Plan for the Estate and Gift Tax Exemption Sunset?
How sure can we be that the tax provisions implemented by the TCJA will sunset in 2026?
“I don’t think that this is a certainty at all,” says Todd Gebhardt, CPA, Director of Tax Services at Commerce Trust. “Only time will tell, but being proactive with the planning is probably the best advice we can provide.”
The importance of developing a solid estate plan is heightened by the high level of uncertainty regarding which direction the exemption amount will move in 2026. Utilizing professionals now to prepare for every potential outcome can make a significant difference in the value of assets transferred to the intended beneficiaries versus how much is used to cover a tax liability.
For example, if an unmarried individual dies in 2024 and their estate, increased by the value of lifetime taxable gifts, is valued at $10 million, under current law they would owe zero estate taxes since they fall below the $13.61 million exemption amount. This same person may be taxed on almost $3.2 million in 2026 if the higher exemption amounts expire*. Without thorough, proactive estate planning strategies, that would divert over $1.2 million to paying taxes instead of being passed along to the intended recipients.
If there is not enough liquidity on hand to pay the taxes owed, the beneficiaries may need to consider liquidating assets to cover the cost. This could result in the beneficiaries not receiving the assets they were expecting in the event they must be sold. Some property, like real estate or cars, is not easily converted to cash and may take time to sell. Proactively planning to resolve how your estate tax liability will be paid can help avoid the complications associated with illiquid assets and ensure your property is distributed to beneficiaries according to your wishes.
Figure 3 - Lifetime Estate and Gift Tax Exemption Amount 2024 vs. 2026
*Note that it is still uncertain what the exact exemption amount will be in 2026. If the TCJA provisions are allowed to simply expire, the estate tax exemption will revert back to 2017 levels, as adjusted for inflation. With that adjustment, the 2026 exemption would be approximately half the 2024 exemption amount.
Estate Planning Guidance from Commerce Trust
Drafting the optimal estate plan requires time and the experience of financial and legal professionals to ensure your plan is appropriately structured to execute your goals. “For families in a taxable estate situation… it’s probably a good opportunity to consider revisiting your estate plan, which is something that you may want to do regularly anyway as a best practice,” says Guy Hockerman, CPA, CFP®, Financial Planning Manager at Commerce Trust.
Commerce Trust offers a team-based holistic approach to wealth management and estate planning. Our team can work with you and your attorney to review how legislative changes may impact your estate plan so you can make proactive adjustments as needed. Learn more about our private wealth management services or contact the Commerce Trust team today to initiate estate planning discussions and ensure readiness for your future.
|
You have worked your whole life to build your legacy, but your estate plan secures it for years to come. Explore our insights from the private wealth management team at Commerce Trust. |
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNER™ in the United States, which it authorizes use of by individuals who successfully complete CFP Board's initial and ongoing certification requirements.
The opinions and other information in the commentary are provided as of April 12, 2024. This summary is intended to provide general information only, and may be of value to the reader and audience.
This material is not a recommendation of any particular investment or insurance strategy, is not based on any particular financial situation or need, and is not intended to replace the advice of a qualified tax advisor or investment professional. While Commerce may provide information or express opinions from time to time, such information or opinions are subject to change, are not offered as professional tax, insurance or legal advice, and may not be relied on as such.
Commerce Trust does not provide tax advice to customers unless engaged to do so. Commerce Trust does not provide legal advice to its customers. Consult an attorney for legal advice, including drafting and execution of estate planning documents.
Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Commerce Trust is a division of Commerce Bank.
Investment Products: Not FDIC Insured | May Lose Value | No Bank Guarantee