Ask the Adviser: What can I do to prepare for the estate tax exemption being reduced? - Rodgers & Associates

Ask the Adviser: What can I do to prepare for the estate tax exemption being reduced?

Q: I have a large estate, and I’ve heard the estate tax exemption will decrease in 2026. What can I do to prepare?

That’s right—in 2026, the Tax Cuts and Jobs Act of 2017 will sunset, and the federal estate tax exemption will revert to what it was before the bill. This essen­tially means it will be cut in half. The exemption for 2023 is $12.92 million (indexed to inflation) which projec­tions show will likely increase to $14 million by 2025; in 2026, the amount will decrease to $7 million.

Most Americans will still fall well below this amount. Yet if your gross estate nears this amount, you’ll want to plan wisely, as the current federal estate tax rate is 40% on any amount above the exemption. Here, we’ll explore a few strategies for antic­i­pating this change.

If you’re a surviving spouse, elect portability

As we’ve mentioned, the 2023 federal gift and estate tax exemption for individuals is $12.92 million. For married couples, this exemption is “portable.” This means that, if your spouse has passed away, you can add your partner’s unused exemption to your own exemption. So, a married couple’s total available exemption in 2023 is $25.84 million.

Note that this election doesn’t happen automat­i­cally. As a surviving spouse, you’ll need to file IRS Form 706, the U.S. Estate (and Generation-Skipping) Tax Return, within five years to add your spouse’s unused exemption to your amount. Neglecting this step could result in a 50% reduction in your available exemption and, of course, a much higher estate tax bill.

Gift assets during your lifetime

One simple way to reduce the size of your future estate is to make gifts to your heirs during your lifetime. In 2023, individuals can make gifts of up to $17,000 ($34,000 per couple) to any other individual without additional reporting. For example, a married couple with four children could give up to $136,000 ($34,000 per child) per year. For larger gifts made to individuals—those above the $17,000 gift exclusion amount—additional reporting is required, and these gifts reduce your lifetime personal exemption amount.

It may make sense to accel­erate your lifetime gifts to heirs before 2026, to take advantage of the current larger exemption.

Complete Roth conversions

If you have a large estate and a high IRA balance, another creative strategy to reduce future estate tax is to consider a Roth conversion. Roth conver­sions allow you to transfer funds from a pretax IRA to a post-tax Roth IRA. This means that you (not your benefi­ciaries) will pay the taxes, which reduces the value of your overall estate by that amount. While it might not seem like a good idea to “volunteer” to pay those income taxes, in most cases the amount would be less than the 40% tax that kicks in after the exemption.

Consider using irrevocable trusts

Irrev­o­cable trusts allow taxpayers to make gifts for the ultimate benefit of their heirs while also retaining some control and protection over the assets. If you want to take advantage of the current high exemption amount but aren’t comfortable making large outright gifts to your heirs, you could consider setting up an irrev­o­cable trust and making gifts to the trust. You can then appoint a trustee to manage these assets, which can be passed to your heirs at the appro­priate time.

There are many different types of irrev­o­cable trusts, and it’s important to work with a qualified estate attorney to ensure that the trust is struc­tured properly.

Regardless of which option you pursue, just remember that the current generous exemption will expire in less than three years. Yet with proper planning, you can take advantage of the current exemption to avoid Uncle Sam taking a large bite out of your financial legacy.