Estate Tax Planning

Without careful planning, much of your life’s legacy could be lost to estate taxes. While a simple will can provide for the transfer your estate to your loved ones, it does not have special provisions for advanced estate tax planning.

The Federal Estate Tax: Exemption & Rate
The Tax Cuts and Jobs Act of 2017 ("TCJA") was signed into law by President Trump on December 22, 2017.  While the TCJA doesn't repeal the federal gift and estate tax law, it does, however, temporarily double the combined gift and estate tax exemption and the generation-skipping transfer ("GST") tax exemption.

Beginning after December 31, 2017, and before January 1, 2026, the combined gift and estate tax exemption amounts double from an inflation-adjusted $5 million to $10 million.  For 2022, the exemption amounts are $12,060,000 per person ($24,120,000 for married couples).  Absent further congressional action, the exemption amounts will revert to their 2017 levels (adjusted for inflation) beginning January 1, 2026.      

The taxable value of the estate is calculated by adding up all the assets owned by the individual and subtracting from that total any of his or her liabilities.  Additional deductions can be taken for qualified charitable deductions as well as administrative and legal costs involved in settling the deceased’s estate.

The tax rate for estates exceeding the exemption amount remains at 40%.  The rate is applied to the taxable estate value that is in excess of the exemption amount.

The Federal Estate Tax: Understanding Portability
In addition to the individual exemption, married couples enjoy an unlimited marital deduction for transfers to one another.  While this is great news for many couples who choose to leave their estate to each other, without proper planning it can result in a forfeiture of some of the individual estate tax exemptions after the passing of the second spouse.  

For example, this can occur when a husband leaves $6 million of his individually-owned assets to his surviving wife who already has $9 million herself, bringing her total net worth to $15M.  The bequest to his wife is not subject to estate taxes because it qualifies for the unlimited marital deduction.  Subsequently, the wife passes away, leaving everything to the children.  While the wife's estate can take advantage of her individual exemption of $12,060,000 (in 2022), the rest of her estate could be subject to estate taxes because her husband’s individual exemption was not used.

To address this issue, the current estate tax law allows for “portability” of individual exemptions between spouses. Stated another way, estate tax portability enables the surviving spouse to use the unused portion of the first-to-die spouse’s estate tax exemption.   Portability is not automatic.  To take advantage of it, an estate tax return must be filed with the IRS within 9 months of the passing of the first spouse, even if there are no taxes due at the time.  Note that portability only applies for estate tax purposes - there is no portability of the GST exemption amount between spouses.  

There are also special issues to consider when a surviving spouse remarries.

As a result of the US Supreme Court decision in United States v. Windsor in June 2013 determining that the federal Defense of Marriage Act is unconstitutional, portability now applies to same-sex couples who are married under state law.   

An alternative to relying on portability is to use a special planning tool referred to as a credit shelter trust (also referred to as a bypass or A-B trust).  If properly established, such trusts work much in the same way as portability, but do not require filing of an estate tax return after the passing of the first spouse.  

A number of states, such as New Jersey, impose a separate estate or inheritance taxes.  While the rates are typically much lower than the federal rate of 40%, the exemption amounts are smaller as well.  As a result of New Jersey legislation passed in 2016 that increased the gas tax, the New Jersey estate tax has been repealed effective January 1, 2018.  However, the New Jersey Inheritance Tax remains in effect (with Class C and Class D Beneficiaries - typically non-lineal descendants - subject to tax up to a maximum rate of 16%). 

Special Planning for High Net Worth Individuals
Individuals and families with significant net worth might still have taxable estates even if they take full advantage of their respective exemptions.  For these individuals, there are a variety of advanced planning techniques that can be crafted to help reduce the estate tax burden, such as strategic gifting programs, life insurance trusts, qualified personal residence trusts, grantor retained annuity trusts, installment sales to intentionally defective grantor trusts. loans to family members, charitable remainder trusts and charitable lead trusts.  

Tax planning strategies are inherently complex but an experienced estate planning attorney with knowledge of estate and gift tax laws can help you establish a comprehensive plan that will allow you pass on as much of your hard-earned assets as possible to your loved ones and beneficiaries.

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