What You Should Know About the Lifetime Estate Tax Exemption

Death and taxes

Benjamin Franklin said “nothing is certain except death and taxes…” And of those two boogey men, taxes may be the scarier. As if we don’t pay enough taxes during our lifetimes, we could be subject to more taxes even upon death! Yes, there is such a thing as a death tax, more commonly known as estate tax.

Understanding the exemption

Simply put, when we die, the value of all our assets are combined into an estate. And if the value of that estate exceeds a threshold, the excess value is subject to an federal estate tax currently as high as 40% (some states also add an additional estate tax). In the past, the federal tax rate was as high as 77%!

Fortunately, there is a Lifetime Estate Tax Exemption (a threshold or exclusion amount) that allows individuals to pass on a certain amount of their estate to heirs without incurring federal estate tax .

The Tax Cut and Jobs Act of 2017 substantially increased the exemption from $5.45 million to $11.18 million, subject to an inflation adjustment. As of 2023 the exemption amount is $12.92 million, but it is scheduled to “sunset” down to about $7 million after 2025.

Whether it’s $12 or $7 million, most Americans will fall under the threshold and will not have to worry about estate taxes. However, many people believe $7 million is too high and would like to reduce the exemption back down to $1 million and also increase the tax rate.

That would create problems for a lot more people, especially in areas with high costs of living like New York and California where the price of a typical family home can quickly exceed $1 million in value.

Making the most of the exemption

The debate around estate taxes is ongoing in DC and we don’t know what changes will come. However, there are things we know now and things we can do to make the most of the current exemptions.

First, know that the exemption (regardless of the amount) is a “use it or lose it” benefit, meaning that any unused portion is not carried over to heirs. So, don’t wait until your death bed to decide how to use this valuable exemption.

Second, don’t assume you can or should only use the exemption at time of death. It is a “lifetime exemption,” meaning it can be used during your lifetime to bestow gifts free from tax. Let’s say your plan is to “leave everything to my kids so they will have a better life.” It could make sense to gift during your lifetime (rather than at your death), so you can see them enjoy that better life (or enjoy it together).

Third, understand the rules to avoid mistakes. Estate tax rules can be tricky. For example, spouses enjoy an “unlimited marital deduction,” meaning all assets can be passed between spouses free from estate taxes. However, relying on this for estate planning could also mean the first spouse to die loses his/her unused lifetime exemption (currently $12.92 million).

This brings us to the final point, which ties into everything already noted, plan ahead carefully! This is not just about how and when to use your exemption, but also how to maximize it. For example, while the current exemption will sunset, the right planning could help preserve the higher current amount.

The bottom line on estate taxes

Unfortunately, Uncle Ben was right about death and taxes. And unfortunately, Uncle Sam may kick you while you’re down and dead with estate taxes. While estate tax may not be a problem for everyone, it is likely to affect an increasing number of people over time.

Currently, the Lifetime Estate Tax Exemption is provides people with a shelter against death tax. Whether you use the exemption during your lifetime or preserve what is unused, it is important to carefully think and plan ahead to utilize and maximize potential benefits.

Keep in mind that laws and rules around estate taxes change over time. It often makes sense to consult with a qualified estate planning attorney and financial advisor who can help you create a wholistic estate plan that aligns with your needs, goals, and current legal considerations.*

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HWL

*Nothing in this post represents personal legal or financial advice. You should consult with professional legal and financial advisors for personal advice.