Don’t Let This Planning Opportunity Pass You By: Using The Federal Estate, Gift Tax Exemption Before It Sunsets

The federal estate and gift tax exemption permits individuals to transfer a certain amount of property or assets to others during their lifetime or after their death without incurring federal estate or gift taxes. The Tax Cuts and Jobs Act of 2017 provided a rare and invaluable map to affluent families and their advisors in the form of locking in the federal estate and gift tax exemption for eight years. Those with large estates immediately saw the exemption amount more than double from $5.49 million per person to $11.18 million and would see this figure rise slightly each year to account for inflation.

Today, this amount is $12.92 million and is projected to be $13.61 million in 2024. This is an unprecedented amount of tax relief but comes with a catch: The exemption is set to “sunset” and to return to 2017 levels (adjusted for inflation) at the end of 2025 unless Congress takes action, and it increasingly seems that will not happen. Adjusted for inflation, the exemption amount is expected to be cut in half to between $6 million and $7 million, potentially exposing this amount to a 40% estate tax rate.

Use It Or Lose It

There are two common misconceptions around the federal estate and gift tax exemption amount. The first is that the current exemption amount is grandfathered for those who have already used a portion of their exemption. This is not the case. If someone has used $10 million of their exemption when January 1, 2026, arrives, they will lose the ability to use the approximately $4 million additional exemption available to them in 2025.

The second misconception is that a taxpayer can choose to apply the exemption amount from the top, first. In other words, someone cannot claim they are using the top $10 million of the exemption amount so that when the amount sunsets, there will still be the bottom $4 million to apply.

Getting Strategic With Your Exemption

A common estate planning strategy is to form an irrevocable trust where the taxpayer serves as the grantor. Assets whose value is most likely to appreciate and assets that can receive a valuation discount are typically gifted to this kind of trust as they are removed from the grantor’s estate and not subject to estate taxation. Valuation discounts are typically applied to closely held business interests.

Often, cash is gifted to the trust to purchase a cash-value life insurance policy whose income tax-free death benefit can be used to meet estate tax obligations. Another advantage to trust-owned life insurance is that the cash inside the policy grows tax-free. This is especially helpful since grantors of grantor trusts are taxed personally on trust income.

Depending on the performance of assets in the trust, it may make sense to borrow against trust assets rather than liquidate them to pay life insurance policy premiums. Another funding technique is to finance premiums by collateralizing the policy and, if needed, other assets. In either borrowing scenario, the terms of the loan and the interest charge may be less costly than paying premiums with cash.

Meet The Millers

Here is an example of how the federal estate and gift tax exemption can be applied. Derek and Daphne Miller are a married couple in their 60s with two adult children. They have a net worth of $40 million, an amount that will almost entirely be subject to a 40% estate taxation when they both die. To reduce and mitigate their estate tax exposure, Derek and Daphne first work with their attorney to form an irrevocable trust.

Next, the couple uses their 2023 unified exemption amount and makes gifts to the trust of $25.84 million in the form of cash and various assets. This means their remaining estate is approximately $14 million and will likely continue to grow while they are alive. To pay for future estate taxes on this amount, the trust purchases a second-to-die cash value life insurance policy with a death benefit of $10 million to take into account the future growth of Derek and Daphne’s estate tax liability. Their children can use the policy’s death benefit to pay the estate taxes without having to sell other assets.

Know The Risks

While an irrevocable trust provides the ability to keep life insurance policy proceeds outside of a grantor’s estate, there are potential downsides. As the trust is irrevocable, the grantor is unable to control the trust’s assets and to make any changes to its beneficiaries. This can be disconcerting, especially in situations where the full exemption amount has been gifted to the trust. Further, the grantor must rely upon the trustee to make any decisions regarding the trust, including the purchase and proper administration of life insurance.

The trustee’s decision-making powers would also extend to how the life insurance policy is funded. If the premiums are financed and the policy and other trust assets are collateralized, there are additional risks. Interest rate fluctuations, changes in policy performance and changes in lending terms may lead to additional costs, the forced surrender of the policy or a lapse in the policy.

The Sun Is Setting On The Platinum Age Of Estate Planning

The federal estate and gift tax exemption has never been as high as it is today. Time is slipping away to construct and implement an estate plan that makes use of the exemption. By consulting with a planning team consisting of a trusts and estate attorney, an accountant with expertise in personal and business valuation and a life insurance professional, estate tax concerns can be put to rest.

DPH Financial Services and their team of trusted partners can assist in taking the appropriate steps. Feel free to reach out with any questions.

The information provided here is not investment, tax, legal or financial advice.

David P. Harris

DPH Financial Services, Inc
License #0F90722
(858) 400-7410p
(619) 335-0112m
[email protected]

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