This post will help you consider estate planning strategies in light of the current federal estate, gift and generation skipping transfer tax exemption, which in 2018 increased to $11.18M and has been indexed for inflation each year since then. However, the exemption amounts are scheduled to revert back to the pre-2018 exemptions (indexed for inflation) when the clock strikes midnight on January 1, 2026.

Remind me what the numbers are.

Below is a basic chart outlining the numbers (per person) pre-2018 as compared to the numbers currently. Remember these numbers relate to federal estate tax. We will discuss state estate tax later in this post.

  2017 2018 2019 2020 2021 2022-2025 2026
Estate & Gift Tax Exemption Amount $5.49 million $11.18 million $11.4 million $11.58 million $11.7 million $12.06 million is current exemption; indexed for inflation each year $5.49 million (indexed for inflation from 2017)
Generation-Skipping Transfer Tax Exemption Amount $5.49 million $11.18 million $11.4 million $11.58 million $11.7 million $12.06 million is current exemption; indexed for inflation each year $5.49 million (indexed for inflation from 2017)
Estate, Gift, and GST Tax Rate 40% 40% 40% 40% 40% 40% 40%

My taxable estate is under $12.06 million – can I stop thinking about tax planning now?

No, definitely not! For one, the law is set to sunset in 2026. That means if you have a $7 million estate, for example, and you do nothing, you may have lost the opportunity to shield your estate from estate tax when the exemption amount reverts back to pre-2018 numbers. Therefore, even if you are well below the $12.06 million threshold, it still makes sense for you to consider lifetime gifting strategies.

You will also want to check your existing estate plan documents to ensure they are still in line with your wishes, since the current federal exemptions could significantly affect your plan. For example, your Will may be drafted so that an amount equal to your remaining federal exemption passes to a “credit shelter” or “bypass” trust for your surviving spouse and children, with the remainder passing outright to your spouse. If you die with a $10 million dollar estate this year and you have used no exemption during your life, the entire $10 million would pass in trust under current law. This may not be in line with your wishes and, depending on where you live, could subject your estate to higher state estate taxes at your death than originally anticipated. In 2017, only $5.49 million (adjusted for inflation) would have passed in trust, with the remaining several million passing outright to your spouse.

My taxable estate is over $12.06 million – what should I do?

Put simply, you should consider giving away more money. The current exemption amount provides a limited window of opportunity to make larger tax-free gifts. Remember that when you make a gift, you are not only removing the gifted asset from your taxable estate, but you are also removing all of the appreciation on that asset from the date of the gift until your eventual death. In addition, similar to those with smaller estates, you should also have your current documents reviewed to see if any changes are warranted.

I’m ready to make additional gifts in order to reduce my taxable estate. What’s the best way to do that?

Many of the same tax savings strategies that made sense per-2018 still make sense under the current law. Let’s start with the freebies, such as annual exclusion gifts and gifts for medical or educational purposes. If you already make annual exclusion gifts, continue doing so. The current annual exclusion limit is $16,000 per donee. Thus, if spouses split their gifts, they can now give away $32,000 per donee each year without using any of their lifetime exemptions. Remember that contributions to 529 plans will eat into this annual exclusion amount. Also, if you make annual exclusion gifts to trusts instead of outright, ensure that you provide any required “Crummey” notices to beneficiaries in conjunction with the gifts.

In addition, gifts for medical or educational purposes continue to remain “freebies”, meaning that the amounts you pay will not count against your lifetime exemption. Remember, however, that in order for the gifts to qualify, you must make them directly to the provider. Do not give cash directly to your grandchild, for example, and then have the grandchild pay tuition directly. Instead, make the payments directly to the health care provider or educational institution. For more information, see Basics of Federal Estate, Gift, and Generation-Skipping Transfer (“GST”) Tax.

With respect to larger gifts, you might wish to “top off” existing trusts by making additional gifts to them with your remaining exemption amount. If you have not created gifting trusts or if the terms of your existing trusts are now less desirable, now is a good opportunity to explore whether the creation of a new trust makes sense for you. There are many types of trusts, and whether any of them make sense for you will depend largely on your financial and family situation.

A common estate planning tool is the “intentionally defective grantor trust” or “IDGT”. This is simply a trust created for the benefit of family members where the grantor remains responsible for paying any income tax generated by gains inside the trust. By footing the tax bill, the grantor is essentially making additional tax-free gifts to the trust, thereby allowing the trust assets to grow at a faster rate than if the trust itself were responsible for the tax bill. In addition, if the grantor loans money to the trust, the interest payments due back to him or her are not taxable income (as they would be if the loan was made to an individual or to a trust where he or she was not the income taxpayer).

The IDGT can be drafted as a “spousal limited access trust” or “SLAT”, which is a somewhat clumsy way of saying: your spouse can have access to the trust, along with your kids and grandkids. Since these trusts are irrevocable, making your spouse a beneficiary provides peace of mind that should you need access to the trust down the line, you have it via potential distributions to your spouse.

Another flavor of trust is the Dynasty Trust, which is a perpetual trust for family members that is intended to last for many generations. Dynasty Trusts are particularly attractive to higher net worth individuals looking to make very large gifts to a trust that they expect to last beyond the lives of their children and grandchildren. Because certain states, such as New York, mandate that a trust end after a certain time period, a Dynasty Trust is typically created in a state that permits perpetual trusts. Delaware is one such state.

In order to remove appreciation from your taxable estate, Grantor Retained Annuity Trusts (GRATs) and intrafamily loans remain effective estate planning strategies so long as interest rates remain low. If you previously made a large intrafamily loan, you might wish to forgive it in order to take advantage of your current exemption amount. If the interest rate on the loan, however, remains favorably low, it may be wiser to keep the loan in place and gift with other assets. It will depend on your unique circumstances.

Each year that you make a gift, even if that gift will not use your lifetime exemption, remember to check with your accountant or attorney as to whether a gift tax return should be filed to report the gift.

What about state estate tax?

It depends on which state you live in. States vary widely in whether and how they impose a state estate tax. New York, New Jersey, and Connecticut, for example, each have very different gift and estate tax regimes that have significantly changed over the last few years or are scheduled to change in the near future. Click here for a quick cheat sheet of the state exemption and rate amounts.

For New Yorkers, the current federal estate tax exemption doesn’t technically change anything about New York’s estate tax, but it does mean that the difference between the federal exemption and the New York exemption is significant. New York’s current exemption amount is $6.11 million, which would have been similar to the pre-2018 federal exemption. Currently, the federal exemption amount is almost double the New York exemption amount.

This discrepancy between the federal and New York exemptions underscores the need to check with your attorney as to how your current estate plan is impacted by the current law. If your current Will, for example, carves out a credit shelter trust for a surviving spouse with the deceased spouse’s federal exemption (as opposed to his state exemption), there could be a significant – and unanticipated – state estate tax bill due at the death of the first spouse.

In addition, the absence of a New York gift tax, combined with the current federal exemption provides an opportunity for wealthy New Yorkers to give more away during life in order to reduce state estate taxes at death. In addition, New Yorkers who have an estate close to the New York exemption amount may wish to consider a gifting program designed to continuously keep the value of their estate below the exemption amount. This is because New Yorkers are subject to a “cliff” whereby if their estate exceeds the New York exemption amount by 5%, they can no longer take advantage of the New York exemption at all. Their entire estate is subject to New York estate tax from dollar one. Read more about the New York estate tax cliff here.

The current federal estate tax exemption has no impact on New Jersey’s estate tax law. Beginning in 2018, the New Jersey estate tax was eliminated in its entirety. So, from a New Jersey state estate tax perspective, it generally does not matter whether you give away dollars during life or at death. The Garden State does, however, still have an inheritance tax that applies to transfers made to people other than your spouse, descendants, or parents. If you are giving away any of your wealth to siblings, in-laws, or cousins, you should ensure that you speak to your estate planning attorney about how New Jersey’s inheritance tax impacts the gift.

Unlike New York or New Jersey, Connecticut’s state exemption amount will eventually be impacted by the federal exemption. For a long time, Connecticut’s state estate tax exemption remained steady at $2 million. In 2022, it is now $9.1 million, and much to the delight of wealthy Connecticut residents, it will rise to match the federal exemption in effect in 2023. Unlike other states that have an estate tax but not a gift tax, though, Connecticut’s gift and estate taxes are unified (similar to federal). So, every dollar you give away during life reduces the amount that you can give away at death without incurring Connecticut estate tax. High net worth Connecticut residents who already used up their previous exemption amount may wish to make an additional gift up to the current CT exemption, with more substantial gifts in 2023.

If you reside in a state that imposes a state estate tax, it is crucial that your estate plan addresses state estate tax. It is also important to note that for many individuals in the highest income tax bracket, current law has essentially made your payment of state income tax more expensive (by severely limiting the state and local tax deduction). For those with significantly high state income taxes, certain state income tax savings strategies such as incomplete non-grantor trusts (“ING trusts”) may prove even more powerful under the current law. An ING trust is a sophisticated type of non-grantor trust that, if drafted, funded, and administered property, can reduce your state income tax bill. There are several considerations in deciding whether to move forward with a strategy like this, such as: does your home state respect them (New York does not, but California still does), are you willing to invest the time and money it takes to set them up (IRS approval is generally recommended, and that is pricey) and do your personal circumstances warrant it?

In summary…

While the federal exemptions are still high, there is an expiration date. The current exemption provides a limited window of opportunity to reduce your taxable estate by making additional gifts. You should consult with your advisor and estate planning attorney in order to determine the optimal way to make those gifts, and also to determine whether your current estate planning documents require revisions in light of this.

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Wealthspire Advisors LLC is a registered investment adviser and subsidiary company of NFP Corp.
This material was created by Wealthspire Advisors LLC. This material was created to provide accurate and reliable information on the subjects covered. It is not intended to constitute legal, tax, or accounting advice or a solicitation. Any communication from Wealthspire Advisors is not a substitute for obtaining legal, tax, or accounting advice from a qualified attorney, tax, or accounting advisor. You should not act upon any such information without first seeking the advice of qualified legal counsel, tax, or accounting advisor with respect to your specific situation. © 2022 Wealthspire Advisors

Richard Yam, J.D.

Rich is senior vice president of trusts & estates, and is based in our New York office.