The federal estate tax is a potential threat to your legacy if you have enjoyed a significant level of financial success. It is only a factor for people with considerable stores of wealth because there is a relatively high credit or exclusion.
This figure is the amount that each taxpayer can transfer tax-free, and the estate tax would apply to the remainder. The tax carries a 40 percent rate, so we are talking about a sizable chunk of your legacy.
In 2022, the federal estate tax exclusion is $12.92 million, and this is the highest it has ever been. It came about as a result of a provision in the Tax Cuts and Jobs Act of 2017 that went into effect in 2018.
On January 1, 2026, the provision in the aforementioned measure will sunset. At that time, the exclusion will go back down to the 2017 level of $5.49 million adjusted for inflation.
The exclusion is portable, so a surviving spouse can use their deceased spouse’s exclusion. There is an unlimited marital estate tax deduction, so a married person can transfer any amount of property to their spouse free of taxation.
When the estate tax was initially enacted in 1916, there was no gift tax, so people would give gifts to get around the estate tax. To close this loophole, a gift tax was enacted in 1924, but it was repealed just two years later.
The loophole remained open for six more years, but in 1932, it was reenacted. There has been a gift tax in the United States ever since then, so the multimillion-dollar exclusion is a unified exclusion.
As a result, the exclusion that is left to apply to your estate will be reduced if you use a portion of your exclusion to give tax-free gifts.
Estate Tax Efficiency
Now that you have the necessary background information, we can look at some of the estate tax efficiency solutions that are available to you. With regard to a foreign spouse, as we have stated, you cannot use the unlimited marital deduction if you are married to a citizen of another country.
As a response, you can establish and fund a qualified domestic trust (QDOT). If you die first, the trustee that you designate will administer the trust. They will distribute the earnings that are generated by the assets to your surviving spouse, and the estate tax would not be a factor.
These distributions would be subject to regular income taxes. You can give the trustee the latitude to distribute portions of the principal, but the estate tax would be applicable on those distributions.
Your children would be the ultimate beneficiaries of the trust. The transfer from the trustee to your children would be subject to the estate tax, but there would be one round of taxation over two generations.
There is a similar outcome if you utilize a generation-skipping trust as part of your estate tax efficiency strategy. Your grandchildren would be the beneficiaries, so the assets would never be transferred to your children.
After your passing, the children will be able to benefit from assets in the trust without owning them. Your grandchildren would inherit the trust after the passing of your children, and the estate tax would apply, but one round of taxation would be skipped.
A grantor retained annuity trust is another possibility. You fund the trust with highly appreciable assets, and you set up a distribution schedule that will theoretically leave nothing left in the trust after the term expires.
The beneficiary that you name in the trust declaration would inherit anything that may remain in the trust after your death. Since this would be an act of taxable gift giving, the IRS will add the anticipated interest accumulation of the taxable value of the trust.
They use the hurdle rate, which is 120 percent of the federal midterm rate. If the assets in the trust appreciate at a greater rate, there will be a remainder after the expiration of the term. This remainder will be transferred to the beneficiary tax-free.
Schedule a Consultation!
These are a handful of the tax efficiency approaches that can be taken, and there are others. Of course, even if your estate is not going to be taxed, you should work with a Burbank estate planning lawyer to develop a plan that is ideal for you and your family.
If you are ready to get started, you can send us a message to set up a consultation appointment, and we can be reached by phone at 818-937-2335.