Estate Tax Changes Coming in the Future & Strategies to Reduce this Tax Impact

Taylor Ledbetter
| October 15, 2024 |

The Tax Cuts and Jobs Act (TCJA) of 2017 significantly changed the federal estate and gift tax exemption. The exemption amount went from $5,490,000 in 2017 to $11,180,000 in 2018. This limit is indexed for inflation and currently sits at $13,610,000 in 2024. This limit allows individuals to leave a large amount of assets to the next generation and not be subject to federal estate tax. However, on January 1st, 2026, this exemption is scheduled to reset or sunset to $5,000,000.

If your estate exceeds the exemption limit, the excess amount is taxed at a rate of 40%. With the exemption being so high in 2024, this hasn’t affected many people. However, once this amount sunsets in 2026, implementing estate planning techniques will be crucial to ensure your assets transfer to the next generation and aren’t eaten up by estate taxes. There are a few ways to take advantage of the current exemption amount and implement these techniques before 2026.

Lifetime Gifting

Lifetime gifting is the simplest way to move assets out of your estate without any gift tax consequences. Currently, you can give any number of people up to $18,000 each in a single year without incurring a taxable gift ($36,000 for spouse “splitting gifts”). However, if your gift exceeds $18,000 to any person during the year, you must report it on a gift tax return (form 709). Not all gifts are subject to this tax. Certain gifts are entirely tax-free, including:

  • School tuition and education payments
  • Charitable donations
  • Medical expenses
  • Political contributions
  • Gifts to a spouse

To qualify for this exception, you must send the check directly to the educational institution if you are paying an individual’s tuition. The same is true when paying medical expenses on behalf of someone else.

Irrevocable Life Insurance Trust (ILIT)

The purpose of an ILIT is to move life insurance policy proceeds out of the owner’s gross estate. The grantor (trust creator) places a life insurance policy into the trust, making the ILIT the owner. The grantor will give gifts to the ILIT each year so that the ILIT can pay the annual premiums on the policy. Typically, the annual premium amounts are less than the annual gift exclusion, so no gift tax consequences exist. It is often overlooked that the death benefit from life insurance is included in the owner’s gross estate, so forming an ILIT to hold the proceeds is a simple solution.

It is very important to know that there is a three-year look-back rule. If an individual transfers ownership of a life insurance policy on his or her own life within three years of death, the policy’s death benefit is included in the gross estate. This three-year rule only applies to gratuitous transfers or incidents of ownership on life insurance policies. It does not apply to a sale of a life insurance policy.

Marital Transfers & Trusts

If you leave assets to a spouse, you are allowed an unlimited marital deduction to reduce your estate taxes. However, this still leaves the surviving spouse the entire taxable estate, including the assets transferred upon the first spouse’s death.  If you don’t want to rely on the marital deduction, there are marital trusts you can utilize that do not disadvantage the surviving spouse.

If we focus purely on minimizing estate taxes, spouses can use a “Bypass Trust” called a “Credit Shelter Trust.” The idea is that a couple transfers property up to the exemption amount of $13,610,000 into this trust at the first spouse’s death. The disadvantage is this type of trust does not qualify for the marital deduction, but the decedent’s estate tax credit will offset estate taxes up to $5,389,800. The trust can be structured so that the surviving spouse receives trust income. Upon the surviving spouse’s death, the assets will be passed on to a noncharitable beneficiary and not included in the surviving spouse’s gross estate.

Charitable Transfers & Trusts

Individuals can also make lifetime charitable transfers or gifts to charities upon death, which reduce the value of the estate and estate taxes. Lifetime gifts also add the benefit of an income tax deduction. Gifts through different charitable trusts may allow the donor to retain the right to use the gifted asset or income until death.

An example of this would be a “Charitable Remainder Trust.” The grantor retains an annuity or unitrust interest for a period of time, and the remainder value passes to a qualified charity. Typically, the remainder interest qualifies for an estate tax deduction if the grantor is not the beneficiary.

As with any tax planning strategy, there is always the possibility that Congress can change the laws related to the gift and estate tax exemption. However, estate planning strategies take time, and with the exemption reducing in 2026, now is a good time to start thinking about whether this could affect you. Implementing more advanced estate planning before 2026 will help reduce your estate’s tax burden and increase the amount you pass on to your loved ones and future generations.