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Estate Planning: Federal Estate Tax Exemption to Drop

Written by: Carrell Blanton Ferris

Posted on: June 21, 2024

Estate Planning Federal Estate Tax Exemption

As we progress through 2024, time is of the essence when considering the future of your estate planning and wealth preservation. The federal estate tax exemption stands at a historic high of $13.61 million this year. However, this unprecedented opportunity comes with a ticking clock, as the exemption is slated to sunset at the stroke of midnight on December 31, 2025. Without legislative intervention, January 1, 2026, will see this exemption cut in half, significantly impacting the estate planning landscape.

The impending deadline presents a critical juncture for effective tax savings; delaying action could result in missed opportunities, especially considering the potential bottleneck as 2025 draws closer. Qualified appraisers essential to this process are expected to face overwhelming demand, emphasizing the importance of proactive engagement in these strategies

Adding an additional layer of complexity, Virginia’s General Assembly has put forth HB 1414, a bill aiming to reinstate the Commonwealth’s estate tax; further underscoring the need for vigilance and timely action.

Luckily, there are many time-tested methods to navigate these challenges. Here are a few of the most common:

Making lifetime gifts to children is often seen as a straightforward approach. With the estate and gift tax exemption as a unified credit, you can give (as of 2024) up to $13.61 million during your lifetime or upon your passing, but not both. Many find this an easy way to gift to their children (and possibly grandchildren) up to the current exemption limit without incurring any transfer tax liability. While it’s a good strategy if you have the means and responsible beneficiaries, not all families are that fortunate. Given the stakes involved, it’s important to weigh the implications of direct lifetime gifts to children versus gifts to trusts for their benefit. Opting for trusts when gifting to your children provides more control over your wealth’s distribution and helps safeguard the gift from the beneficiary’s creditors, protects it in case of a divorce, and ensures no estate taxes are incurred when passing the remainder of the gifted assets and their appreciation to future generations when your children pass (thus avoiding GST taxes).

Consider, for example, the following:

Kevin and Anne are married, and they are concerned about a potential decrease in the estate and gift tax exemption amount in the coming years. Their estate is valued at $30million, they are comfortable living the rest of their lives on $6 million and decide that they would like to go ahead and make a substantial gift to their daughters. While they have full confidence in their three girls to be good stewards of the funds, they want to ensure that the funds are protected and stay in their family.

They establish three gifting trusts, one for the benefit of each daughter, and fund them utilizing $13.61 million of Kevin’s exemption and $10.39 million of Anne’s exemption. They pass away in the same year when the estate and gift tax exemption has been reduced to $7 million per person. Even though they have gifted more than the $14million allowed between the respective exemptions in effect at their deaths, they will not need to worry because they took advantage of the opportunity when the exemption was at a historic high and the IRS has taken the position that it will not punish taxpayers with a clawback provision. See Treasury Regulation Section 20.2010-1. As a result, Kevin and Anne have saved over $6 million in estate taxes assuming a 40% estate tax rate at the time of their deaths. If you think that is impressive savings, also consider that any appreciation of the assets gifted are also out of their estates and, therefore, are not subjected to the 40% tax at their death. With properly structured provisions in the gifting trusts and proper allocations of GST tax exemption, these funds could continue to grow and all the principal and appreciation would be outside of each daughter’s taxable estate in the future, regardless of how far the exemption falls over time. All and all creating massive tax savings for the family. 

Irrevocable Life Insurance Trusts (ILITs) are a valuable tool in wealth transfer planning. By setting up an ILIT, you can transfer an existing insurance policy or have the trustee purchase a policy using gifted funds. As the donor, you can make gifts to the ILIT within the annual gift tax exclusion limit (presently $18,000 per person). These gifts are then used by the trustee to pay the insurance premiums, provided that the beneficiaries do not elect to exercise their withdrawal right. Since the policy is owned by the trust, the premiums and death benefit are not part of your taxable estate provide you do not violate the infamous three-year rule under Internal Revenue Code Sections 2035 or 2042. This strategy can help preserve liquidity in the estate, preventing the need to liquidate assets like family land or businesses to cover estate tax obligations.

Spousal Lifetime Access Trusts (SLATs) offer a strategic way for a spouse to transfer assets to an irrevocable trust, benefiting the other spouse, children, and/or grandchildren. By utilizing the donor spouse’s exemption, a SLAT safeguards the contributed assets and their appreciation from potential estate taxes. With a SLAT, the trustee has the authority to make discretionary distributions to the spouse. Although distributions lose the trust’s tax benefits, knowing that the spouse can benefit provides peace of mind that the funds could be accessed if needed. By establishing a SLAT, one spouse can secure the current high exemption while granting the other spouse access to funds through the trustee, potentially saving substantial estate taxes in the future.

Grantor Retained Annuity Trusts (GRATs) are an efficient way for a donor to transfer asset appreciation to beneficiaries without using any (or only using a minimal amount) of the donor’s gift tax exemption. After the donor transfers property to the GRAT and until the expiration of the GRAT term, the trustee of the GRAT will pay the donor an annual annuity amount. This provides the donor with a stream of income for the term. The annuity amount paid to the donor is calculated using the applicable federal rate as a specified percentage of the initial fair market value of the property transferred to the GRAT. Numerous strategies can be implemented with GRATs. A Walton or zeroed-out GRAT is one of the most common strategies used in wealth transfer planning. The Walton GRAT, named after the Walmart heiress Audrey J. Walton, is intended to result in a remainder interest (i.e., the part that is considered a gift) that is valued at zero or as close to zero as possible. This allows for any appreciation above the applicable federal rate to pass to the beneficiaries after the annuity term ends. In other words, not only were you successful in transferring an asset out of your estate with no or minimal transfer tax liability, you’ve also managed to transfer the appreciation gained over the term. In short, if your goal is to transfer an appreciating asset without having to cut deeply into your gift tax exclusion, then you can consider a GRAT as part of your overall wealth transfer planning.

Virginia Qualified Self Settled Spendthrift Trusts (QSSSTs “pronounced as Quists”) are a type of Domestic Asset Protection Trust outlined in the Code of Virginia. Very few states have statutes allowing for the creation of a self-settled asset protection trust, so many are surprised to learn about this unique planning opportunity. The QSSST is an irrevocable trust that, unlike any of the other trusts outlined above, allows the donor to remain a beneficiary of the assets. In fact, the Code of Virginia explicitly provides for this. Drafted properly, the QSSST will not only provide you excellent creditor protection but can also be used to lock in the current high estate and gift tax exemption. A transfer to a QSSST can count as a completed gift for gift tax purposes so long as the assets transferred are not reachable by creditors of the donor. Under the applicable Virginia statute, a “qualified interest” in a QSSST cannot be attached by a judgment creditor. There are other factors at play, but with careful drafting you can have your exemption frozen at this great exemption amount and have the peace of mind knowing that should you ever need to live off assets in the trust, you can. Just think of it as a super secure rainy-day fund capable, if untouched, to pass on massive wealth for generations.

Each of the above methods offers unique advantages tailored to safeguarding your legacy. These mechanisms not only leverage the current high exemption but also facilitate the strategic positioning of your estate to benefit from appreciation outside the taxable estate, fortifying your assets against future estate taxes.

Action Step: With the window rapidly narrowing, now is the moment to review your estate plan if your estate is above $7 million or if you anticipate appreciation of your assets to push you above $7 million in the years to come. Contact us to schedule a consultation where we can explore the strategies best suited to securing your wealth for generations. Don’t delay because estate planning of this caliber takes time to develop and to implement. Attorneys, CPAs, appraisers, and insurance advisors are already busy with the sunset looming, and we will only get busier as the deadline approaches. If you believe you will have a taxable estate after the exemption plummets in 2025, act now; time is of the essence.

Related Article:

Irrevocable Life Insurance Trusts (ILIT) and Estate Planning

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