Understanding the Federal Estate Tax Exemption Changes: A Call to Action Before 2026
As we approach 2024, it is essential for individuals and families to understand the significant implications of the Federal Estate Tax Exemption, currently set at a historically high $13,610,000. This amount reflects a substantial increase since the early 2000s, but it’s important to recognize that these advantages are at risk of diminishing. If Congress does not take action, the exemptions associated with the estate and gift tax will revert to pre-2017 law on January 1, 2026. Consequently, the exemption will be cut by approximately half, leading to an urgent need for proactive planning.
A Brief History of the Federal Estate and Gift Tax
The federal estate and gift taxes have undergone numerous changes since their inception. These taxes apply to an individual’s right to transfer property during their life or at death. The estate tax exemption, the threshold amount that can be transferred without incurring taxes, has seen increases, starting from approximately $120,000 in the 1970s to the current level. By the late 2000s, the exemption had only reached about $3.5 million, while the top tax rate stood at over 70%. In 2010, the estate tax was temporarily eliminated but reinstated in 2011 with a new exemption of $5 million. Importantly, since then, these figures have been indexed for inflation, culminating in today’s significant $13.61 million exemption due to the Tax Cuts and Jobs Act (TCJA) of 2017.
The Tax Cuts and Jobs Act of 2017
The TCJA, signed into law by President Trump, drastically altered the landscape of taxation for many individuals and corporations. The act included:
- Doubling the income tax standard deduction
- Compressing income tax rate brackets
- Lowering the top income tax rate to 37%
- Doubling the Federal Estate Tax Exemption
As of 2024, the exemption stands at a generous $13.61 million per individual, meaning a married couple can transfer the equivalent of nearly $27.22 million without triggering estate taxes. However, this is a fleeting advantage; the benefits for individuals under the TCJA are set to expire by the end of 2025.
Impending Changes: The Sunset of the Estate Tax Exemption
One pivotal aspect of the TCJA is the impending sunset of the tax benefits for individuals. As we head toward 2026, estate tax exemptions and rates are expected to revert to pre-2017 levels, resulting in an estimated dramatic reduction in the exemption amount. This transition presents a stark contrast in tax implications.
For example, consider an unmarried individual with an estate valued at $20 million and no prior gifts:
- If they pass away in 2025, the estate tax would be calculated as follows:
[
\$20,000,000 – \$15,400,000 = \$4,600,000 \quad \text{(estimated 2025 exemption)}\
\$4,600,000 \times 40\% = \$1,840,000 \text{ estate tax}
] - Conversely, if they die in 2026, the tax will be:
[
\$20,000,000 – \$6,500,000 = \$13,500,000 \quad \text{(estimated 2026 exemption)}\
\$13,500,000 \times 40\% = \$5,400,000 \text{ estate tax}
]
The difference in estate taxes between dying in 2025 versus 2026 compounds to an eye-watering increase of over $3.5 million. The effect is even more pronounced for married couples, highlighting the urgent need for estate planning.
Strategies for Utilizing the Current High Exemption
With the clock ticking down to 2026, there are strategic actions individuals can take to maximize their exemption. Here are some considerations:
-
Gifting Today: Utilizing the high exemption available today means making gifts of property or cash to family or loved ones while the exemption is elevated. This action effectively "freezes" the exemption at its current level, protecting assets from future taxation.
-
Spousal Lifetime Access Trust (SLAT): For married couples, creating a SLAT is a compelling strategy. A husband might create a trust for his spouse that utilizes his exemption while still giving him indirect access to the assets. This arrangement can also provide asset protection benefits, shielding the assets from creditors.
- Custom Tailored Planning: Each family’s situation is unique. Engaging with estate planning professionals can uncover various strategies suited to individual needs, from charitable trusts to irrevocable life insurance trusts.
Urgency in Estate Planning
The lessons learned from previous years underscore the importance of acting promptly. Procrastination in estate planning can lead to missed opportunities, especially as the potential reduction in exemptions looms closer. In 2021, many speculated on imminent changes to the tax law, which led to overwhelming demand for services from legal and financial professionals, illustrating how late actions can complicate effective planning.
Conclusion: Take Action Now
The future of estate and gift taxes remains uncertain, with potential implications for millions of Americans. To safeguard assets and minimize tax burdens, planning based on today’s rules is crucial. Actively engaging with skilled planners can help navigate these complex waters, ensuring families can preserve wealth for generations to come. The time is now to assess your estate, consider strategic moves, and take action before the opportunity to utilize today’s exemptions fades away.
Pinnacle Financial Partners does not provide legal or taxation advice. This summary serves as general information and not specific advice tailored to individual situations. Consultation with professional advisors is recommended for personalized guidance.
