How to Prepare for the Sunset of the High Federal Estate Tax Exemption

The federal estate and gift tax exemption allows individuals to give away money or assets during their lifetime or at death tax-free up to a threshold amount, which since 2018 has stood at $13.61 million per person or $27.22 million for married couples. Since less than 0.1 percent of estates paid any estate tax in 2020, the high exemption has minimized the number of people subject to taxation.

However, the current federal estate tax exemption will sunset at the end of 2025 unless new legislation is passed. At that point, the exemption will fall to the pre-2017 levels of around $6 million or $7 million per person. This change is significant for residents of New Jersey, where the state estate tax was eliminated in 2018. However, New Jersey does have Inheritance Taxes that are determined by who receives an inheritance, regardless of how much they receive.

Here are some concrete steps estate planners can take to prepare for the looming tax exemption reduction:

1. Gift assets before 2026 — One of the most effective strategies to reduce potential estate tax liability is to make gifts during your lifetime. At present, you can give up to $18,000 per recipient without affecting your lifetime exemption. This allows for wealth transfers to heirs now, rather than having those assets included in your estate when the exemption lowers. 
2. Set up irrevocable trusts — By transferring assets into an irrevocable trust, you remove them from your taxable estate. A grantor retained annuity trust (GRAT), for example, allows the creator to receive annuity payments for life and to pass the remaining assets to beneficiaries.
3. Create irrevocable life insurance trust (ILIT) — By placing life insurance in a trust, you exclude the proceeds from the estate, facilitating greater wealth transfer to beneficiaries.
4. Create a spousal lifetime access trust (SLAT) — This type of irrevocable trust allows for tax-free distributions to a spouse during his or her lifetime. When the spouse dies, the remaining trust assets pass to the beneficiaries named in the trust document. The lifetime estate tax exemption can be applied to them, which can shield future appreciation on SLAT assets from taxes.
5. Utilize portability for married couples — Married couples can take advantage of the “portability” feature of federal estate tax law, which allows the surviving spouse to use any unused portion of their deceased spouse’s exemption. An election for portability must be made on the deceased spouse’s estate tax return, even if no tax is due at the time of their death. 
6. Explore charitable giving — Charitable donations can reduce the size of an estate while also supporting causes the individual cares about. New Jersey residents can donate to qualified charitable organizations and receive an estate tax deduction for the full value of the gift. Establishing a charitable remainder trust or donor-advised fund can allow individuals to maximize their charitable impact while reducing their taxable estate. 

An estate plan in place today may be outdated or may rely on formulas tied to the current exemption amounts. You should consult with an estate planning attorney to review your wills, trusts and other documents. By taking proactive steps now, you can mitigate the impact of the federal estate tax exemption sunset and preserve more of your wealth for future generations. There are good and bad consequences of your decisions. 

At The Paton Law Firm LLC in Fair Lawn, I advise northern New Jersey residents on matters pertaining to estate planning, including inheritance and estate taxes. Call 201-470-4801 or contact me online for a free initial consultation.