Since the Tax Cuts and Jobs Act of 2017, the federal estate tax exemption limit has doubled from $5 million per individual to $10 million per individual (indexed for inflation). This means that the estate and gift tax exemption limit in 2021 will be $11.7 million in 2021, up from $11.58 million in 2020.
This doubling of the exemption limit and subsequent annual adjustment for inflation will remain in effect until 2025 – unless the new administration supersedes the act with a recent proposed change back to 2009 exemption limits (a modest $3.5 million per individual) and an increased tax rate (45 percent, up from the current 40 percent).
To do so would require congressional support, which will be determined in the upcoming January Georgia Senate runoff. Suppose the new administration's proposed tax changes take hold. In that case, thousands of Americans will need to reconsider and overhaul their estate plans to account for a drastic cut in the exemption limit.
If it does not, then the estate tax exemption limit is slated to continue to adjust annually until 2026, at which point it will revert to $5 million per individual, indexed for inflation. Unless, on the other hand, Republican legislators find a way to make the doubled exemption permanent.
Either way, it is essential to be aware of how a sudden change in estate and gift tax exemption limits might affect your estate plans, especially with a hefty potential tax rate of 45 percent.
First, federal and state estate taxes are determined by different pieces of legislation. Only 17 states levy state estate taxes when an individual dies, with varying limits of exemption and tax rates. While the federal estate tax exemption limit is affected by portability (allowing an individual to dip into their spouse's exemption and effectively double their exemption by passing wealth on as a married couple), some states, like New York, do not recognize portability.
Some states separate estate taxes and inheritance taxes. And most states, like California, do not have a state estate tax. Any changes made to the federal estate tax exemption, and the federal estate tax rate, will not affect state estate taxes. However, state legislators may change state estate taxes in response to changes in the federal estate tax. Only time will tell.
The federal estate tax exemption doubles as an individual's lifetime gift tax exemption dipped into whenever a person makes a gift that exceeds their annual gift tax exemption, which currently stands at $15,000. In other words, any contributions made within a year past the $15,000 limit will begin to eat into your estate tax exemption limit.
Note that certain types of giving do not count towards your gift tax limit – these include paying for medical and tuition expenses, so long as your contributions are made directly to the respective institutions. Naturally, your ability to give lifetime gifts without incurring a gift tax will be affected if changes are made within the next tax year by the upcoming administration.
Speaking to those fears, the IRS assured taxpayers in 2019 that they would not "clawback" lifetime gifts if the exemption is lowered. Thus, taxpayers were encouraged to use their lifetime gift tax exemption of $11.58 million (in 2020) to anticipate a potential drop in individual immunity to $3.5 million. Otherwise, the difference would be effectively "lost."
If you plan to gift big this year to make use of your lifetime exemption before an anticipated tax change, it is wise first to contact a tax professional and discuss your situation. There are good and bad ways to make gifts to your loved ones, concerning what you will consequently owe the government. Either way, you can expect to make appropriate changes to your estate plan to reflect the potential change in exemption limits.
You may want to explore your trust options as well, as irrevocable trusts in particular – such as a grantor retained annuity trusts (GRATs) – can provide an immense benefit in minimizing taxes on the transfer of large financial gifts. Another attractive trust option for those looking to make use of their lifetime exemption before tax changes are made, whether as a result of a new administration or coronavirus bailouts, is a spousal lifetime access trust (SLAT).
Alternatives exist for non-married individuals, such as domestic asset protection trusts (DAPTs). Explore these options with a trust and estate planning professional if you want to make sure you are making the most of your exemptions without being overly cautious or wasteful in the process.
On the other hand, those who have made full use of their $11.58 million lifetime gift exemption tax limit can now gift an additional $120,000 ($240,000 for married couples) and may want to consider the best approach doing so before significant tax changes occur.
Estate plans are more than just a single document detailing who gets what. They can help families minimize the costs of transferring complex assets, determine end-of-life care, establish an essential hierarchy of responsibility in the event of a loved one's incapacity, resolve (officially and on paper) who takes on guardianship of minor dependents within the family, and much more.
With the potential tax changes looming over us in 2021 and onwards, it may be time to review your existing estate plan and make appropriate changes. However, consult with a professional before making premature decisions. Every plan is different, and individual considerations are critical. These changes may not necessarily apply to you and your plans. However, you may want to heed instead 2021 changes made to retirement account contribution limits and how they impact your estate and bequeathment planning, for example.
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