Protect Your Estate from Taxes

Death and taxes are two of life's unavoidable certainties! Though often viewed through separate lenses, in the financial world, the two are often intertwined. When an individual passes away, their estate could be faced with the prospects of estate taxes, which can be as high as 40%!

Estate Taxes – Will I Have to Pay?

Currently, the individual lifetime gift-tax exemption amount is $12.920M. This means an individual taxpayer won't be subject to gift tax until they have depleted that exemption amount through gifting or death transfer.

The IRS allows you to gift up to $17,000 (for 2023) annually to unlimited beneficiaries ($34,000 if you are married, filing jointly, and gift splitting) without incurring gift taxes. However, if you gift an amount exceeding the IRS-established threshold, that difference will be applied against your lifetime exemption limit. While the current exemption figure will cover most individual estates, it becomes slightly more problematic with married couples.

For example, assume we have a married couple where each spouse has an estate valued at $10M. As it stands now, both spouses are protected from estate taxes based on the current exemption amount (essentially highlighting that if they were single and both passed, neither would owe estate taxes). Now let's assume spouse A passes away and spouse B inherits the deceased spouse's estate bringing the surviving spouse's estate to a value of $20M. If the surviving spouse were to pass away, they would be subject to estate taxes for anything exceeding the current exemption amount, in this case, $7.080M. With the highest gift tax rate at 40%, you are looking at a tax bill well north of $2.8M!

What options might you have to avoid this tax hit? While there are many estate planning techniques to transfer wealth during one's lifetime, I want to focus on 'portability.'

Maybe you think estate taxes won't apply to you. Be aware that without Congressional action, the exemption amount is scheduled to be reduced significantly in 2026. So while you may not owe taxes now, your situation and the tax code could be very different at the time of your passing.

Portability – What is it? How does it work?

Portability allows for transferring a deceased spouse's unused exclusion amount (DSUE amount) to the surviving spouse. This is accomplished by filing form 706 upon the first spouse's death. Let's revisit the previous example and assume spouse A did not use any of their lifetime exemption amount.

In this scenario, upon filing form 706, spouse A will transfer their unused exclusion amount of $12.920M to the surviving spouse bringing spouse B's total exemption amount to $25.84M. Upon the death of spouse B, the entire $20M estate will pass to heirs estate-tax-free as the new combined exemption amount sheltered all of the married couple's assets.

There are a couple of important caveats to remember. First, filing deadlines. If you are required to file a Federal estate tax return, your deadline to file form 706 is nine months (plus a 6-month extension if requested) after the date of death. When a Federal estate tax return is NOT required, you have up to five years from the decedent's death to file form 706. Though it is possible to request an extension beyond these parameters if you fail to file the form on time, the process is arduous, and there is no guarantee the extension request will be granted.

A second important stipulation to pay attention to is the sun-setting of the current exemption amount. If Congress fails to make these increased exclusion amounts permanent, they will revert to pre-TCJA levels of approximately $5M (adjusted for inflation) starting in 2026. Of note, the IRS has confirmed that the current available exemption will not negatively impact a decedent's estate if the death occurs in 2026 (or later) and the increased exclusion provisions lapse.

In layman's terms, if you make a gift during your lifetime of, say, $10M and you pass away in 2026 when the exclusion amount has reverted, the excess amount of your gift will not be brought into your estate for gross estate calculations.

Summary

Suffice it to say there are ample estate planning techniques to help reduce your gross estate amount before death. Whether through annual gifts to children/grandchildren, charitable donations, or trust planning, it's important to navigate all means to ensure you can meet your financial goals and maximize your post-death intentions.

Portability can play an important role in your estate planning, so be sure to have this discussion with your financial advisor to limit the impact estate taxes will have on your legacy.

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