by Isler CPA -
The US federal government imposes taxes on the transfer of assets when an individual passes away. The current federal estate tax exemption is $12.06 million in 2022 (it was $11.7 million in 2021). However, this exclusion is set to expire on December 31, 2025, and revert to the pre-2018 level, which was $5.49 million. This reduction in the exclusion could leave many taxpayers with estates worth less than the current exclusion, but more than the 2026 exclusion, concerned about their potential estate tax liability. Estate planning is an essential part of wealth management, and it’s essential to ensure that the wealth you’ve worked hard to accumulate is protected for future generations. One critical consideration is minimizing the amount of estate taxes your beneficiaries will have to pay when you pass away. If you’re wondering if estates worth less than the current estate exclusion, but more than the estate exclusion in 2026, can avoid paying estate taxes when they die, this article is for you.
Gift Taxes and Estate Tax Exclusion:
Firstly, it is essential to understand how gift taxes work and how they can affect your estate. When you give someone a gift, you may be required to pay gift taxes, which are taxes on the transfer of property from one person to another. However, the current gift tax exclusion is $15,000 per year per individual. This means that you can give up to $15,000 to any one person without being subject to gift tax. If you give more than this amount, you will be subject to gift tax, and the excess will reduce your estate exclusion amount.
The estate exclusion is the total amount of assets that can be transferred to heirs without incurring estate taxes. The estate exclusion amount is currently $12.06 million per individual in 2022, up from $11.7 million in 2021 [3]. However, this amount is set to revert to the pre-2018 level of $5 million, adjusted for inflation, in 2026 when the Tax Cuts and Jobs Act expires.
Trust Assets and Estate Taxes:
One way to reduce estate taxes is by transferring assets outside of the grantor’s estate. Trusts are one way to do this because they are taxed as persons and must file and pay state and federal income taxes. When you transfer assets to a trust, the assets are no longer considered part of your estate, which can reduce your estate tax liability. Therefore, using a trust can allow you to transfer more wealth than your lifetime gift and estate tax exemption.
Irrevocable Trusts:
Irrevocable trusts are a popular way to transfer assets outside of the grantor’s estate. Gifts to an irrevocable trust reduce the estate size and the assets will grow outside of the trust, which can reduce your estate tax liability. However, the donor cannot retain control over the assets once they are transferred to the trust. This means that the donor cannot access the assets or change the terms of the trust once it has been created.
Spousal Lifetime Access Trust (SLAT):
A Spousal Lifetime Access Trust (SLAT) is another type of trust that can be used for transferring wealth outside of an estate. A SLAT is an irrevocable trust set up while both spouses are still alive, in which the other spouse is the designated beneficiary. This means that the non-donor spouse can continue to receive income from the estate assets. SLATs provide an opportunity to take advantage of the current federal exclusion before it sunsets, or expires, on December 31, 2025. A properly structured SLAT provides the donor limited, indirect access to the trust, allowing the donor spouse to make a gift to their beneficiaries. In addition, gifts to the SLAT, unlike the irrevocable trust, allow the grantor to give to the trust up to the annual exclusion amount for each beneficiary.
Another benefit of the Spousal Lifetime Access Trust is that the grantor may continue to receive income from the estate assets. Additionally, the donor beneficiary can retain control of the assets in the SLAT, which is not the case with an irrevocable trust.
In conclusion:
The 2026 gift and estate tax exclusion amount is set to decrease significantly, which will increase the number of estates subject to federal gift and estate taxes. However, by using a Spousal Lifetime Access Trust instead of an irrevocable trust, individuals can minimize the amount of taxes owed and ensure that their beneficiaries receive the maximum benefit from their estate.
