Rarely is there a clear-cut loophole in the tax laws to help people save money. Despite fuel costing nearly $5.00 per gallon, a few strawberries setting us back $6.00+, and a significant decline in the value of our stocks, there is a silver lining – albeit a time sensitive one!
Tax laws get a lot of coverage from news outlets and social media. What doesn’t get talked about much is the limited window in our federal tax laws which allow individuals until December 31, 2025 (or sooner if Congress acts before then) to save a lot of estate tax. Because I’m talking about tax law, which is both complicated and boring for most, I’ll do my best to simplify.
To best understand the time-sensitive planning techniques available, we first must understand the nature of taxes. Following is a high-level overview:
- Income tax – Unless you reside in South Dakota, this tax is reported on your annual tax returns showing your earnings for the calendar year;
- State and Federal taxes, FICA, and Medicare tax – For most W2 workers, these taxes show up on your pay stubs and reduce your gross income to result in your net income;
- Capital Gains tax – A tax of 15%-20% is applied to the gain on the sale of most assets (e.g. you purchase a commercial building for $150,000 and then sell it for $250,000. A capital gains tax is assessed on the $100,000 gain in value);
- Inheritance tax – Beginning in 2023, if you are a resident of Nebraska, an inheritance tax of 1%-15% is imposed upon a person (other than a surviving spouse) who receives an inheritance. Iowa residents may also be subject to inheritance tax, but it is being phased out over the next few years;
- Federal Estate tax – Any value of an estate exceeding the applicable estate tax limit when a person dies is taxed at 40%.
The money-saving techniques addressed in this article primarily concern the 40% federal estate tax. The exemption for this federal tax is at an historic high, with the 40% tax only applying to individuals who die with more than approximately $12 Million or a married person who dies with a collective estate worth more than approximately $24 Million. However, effective January 1, 2026, or sooner if Congress changes the law before then, the federal estate tax exemption will be cut in half. This means the 40% federal estate tax will apply to individuals with approximately $6 Million, or a married person with a collective estate of approximately $12 Million.
Consider the following example: In 2026, an unmarried person dies with an estate worth $12 Million. The estate tax exemption is $6 Million, leaving the remaining $6 Million subject to the 40% federal estate tax. This results in a federal estate tax of $2.4 Million! Having to come up with this type of money is how farmland, businesses, and other substantial assets can be lost.
The current federal estate tax law is written so that if a person makes a gift before January 1, 2026, the gift cannot be “clawed back” for tax purposes, even when the federal estate tax exemption is cut in half. In other words, even if the estate tax exemption is reduced to $6 Million for an individual, that individual may gift $6 Million before 2026 and the remaining $6 Million is not taxed. Hence the limited window for Americans to take advantage of gifting before the 2026 deadline.
Following are some types of gifting strategies to avoid or reduce the 40% federal estate tax:
- Gift property to an irrevocable trust. Subject to the type of trust, you may receive the income from the trust, the assets transferred will pass to your designated beneficiaries at your death, and the value of the gifted asset is exempt from the 40% federal estate tax.
- Create a charitable remainder trust or charitable lead trust. These types of charitable trusts get the money out of your estate while still giving income to you for life (Charitable Remainder Trust) or providing income to the charity of your choice now and paying out the Trust assets to your designated beneficiaries at your death (Charitable Lead Trust).
- If you are not concerned about maintaining an interest to the income from the gifted asset, make an outright gift. Under current law, each individual may gift $16,000 per year per recipient, without filing a gift tax return. A married couple may gift $32,000 per year per recipient. If you gift more than the annual exclusion, that is fine and no gift tax will be owed so long as the gift is under $12 Million, although a gift tax return will need to be filed showing the value of the gift.
- Establish a charitable account individually or through a community foundation. Often these accounts are funded with assets with a low tax basis (e.g. stock which has appreciated in value), thereby not only reducing the federal estate tax, but saves the 15%-20% capital gains tax if the asset were sold, and utilizes various tax deductions.
If you are concerned about federal estate tax, don’t miss out on this limited opportunity!
The information contained above is for informational purposes only, and is not legal advice or a substitute for legal counsel. You should not act or rely upon this information.