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Tax planning always requires forethought; however, this upcoming year it is even more vital. The Tax Cuts and Jobs Act (TCJA) doubled the estate tax exemption to $13.61 million for individuals and $27.22 million for married couples; but, this is only for 2018 through 2025.
This temporary exemption is set to sunset on December 31, 2025. If the exemption expires it will revert to approximately $7 million per individual. As a result, it is essential to be aware of possible changes and consider strategic moves that could preserve wealth. By staying informed and proactive, you can better navigate the shifting tax environment and optimize your estate planning efforts in case the current exemptions expire.
Overview Of Gift Tax
The taxable portion of an estate is subject to a flat 40-percent tax rate. The estate tax applies to a decedent’s gross estate which includes stocks, mutual funds, bonds, real property, and life insurance proceeds from policies owned by the decedent It is important to note that the taxable estate equals the gross estate less deductions. Estate and gift taxes allow an unlimited deduction for transfers to charity, a surviving spouse, and to support a minor child. Estates may also deduct funeral expenses, legal and administrative fees, and debts. Beyond that exemption, donors pay gift tax at the estate tax rate of 40 percent.
Historical Context: Lessons From 2012
The uncertainty of tax exemption sunsets is not new. In 2012, a similar situation occurred when exemptions were set to decrease from $5 million to $1 million. At the eleventh hour, Congress passed legislation allowing the $5 million exemption to continue. Unfortunately, many people were scared and it prompted them to act hastily, resulting in planning mistakes.
For example, a business owner believed that the tax exemption would sunset and rushed to meet the maximum amount of the exemption and placed $5 million of liquid assets in an irrevocable trust. Had they prepared they would have been able to place harder-to-value business assets into the irrevocable trust. Unfortunately, an appraisal is required by tax regulations to transfer certain assets into trusts or other protective structures.
Entrepreneurs also made hasty decisions by employing estate freeze techniques in company stock for their minor children, often without properly capping beneficiaries’ interests. Such oversights underscored the importance of thoughtful, well-informed planning and the potential pitfalls of reacting impulsively to looming tax changes. By examining these past errors, we know to have set plans in place in case the exemption is not extended.
Effective Use Of Trusts
Establishing a spousal lifetime access trust (SLAT), which could provide more control and access to trust assets. A SLAT allows one spouse to make a gift into a trust that benefits the other spouse, maintaining access to the trust’s income and principal while keeping the assets out of the estate for tax purposes. Similarly, a grantor retained annuity trust (GRAT) can be used to transfer appreciating assets while minimizing gift taxes. This allows you to lock in current asset values and transfer future appreciation to beneficiaries at a reduced tax cost.
Estate Freeze Techniques: What You Need To Know
Estate freezing techniques aim to lock in the current value of assets and minimize future tax liabilities. These strategies allow the appreciation of assets to benefit heirs rather than being subject to high estate taxes. When employing an estate freeze, it’s essential to carefully select which assets to freeze and the method of transferring them to the intended beneficiaries. The selection process should involve thorough analysis and consultation with professional advisors to ensure it aligns with your overall financial goals and tax planning objectives.
One popular estate freeze technique is the use of a grantor retained annuity trust (GRAT), which enables you to transfer appreciating assets to your beneficiaries while minimizing gift taxes. Another effective method is utilizing family limited partnerships (FLPs), which can provide substantial discounts on the value of transferred assets for tax purposes. Each technique has its own set of rules and requirements, making it crucial to understand their implications fully.
By leveraging these techniques wisely, you can effectively manage the growth of your estate and shift future appreciation to your heirs at a lower tax cost. However, the success of these strategies hinges on careful planning and precise execution.
Creating A Comprehensive Tax Planning Strategy
Since the estate tax exemption might decrease at the end of 2025, it is important to put a plan into place. With a plan in place, you can decide to employ one of these techniques at the end of 2025. A smart strategic move is to wait until December of 2025 to employ one of the aforementioned tactics. This will ensure that you do not employ one of these tactics prematurely. Tax planning requires forethought, timing, and a constant analysis of the ever evolving legal landscape. Preserve your wealth and strategize your estate over the course of the next year.
