The new tax law put in place in 2018 doubled the Estate Tax Exemption, and in 2021 it went up even more. In 2016 the Estate Tax Exemption was $5,490,000 per person and it is now $11,400,000 per person. Double this amount for a married couple for a total of $23,400,000.
What does this mean for you? Well, if you have less than $11.7 million in assets or $23.4 million as a couple, your heirs won’t pay any federal Estate Tax on your assets when you die. If you have more than the Estate Tax Exemption, any amount you have over the exemption will be taxed at approximately 40%. For example, if you are single and die with $21.7 million in assets and have not properly planned to avoid the Estate Tax, your heirs will pay the tax on the amount over $11.7 million, which in this example is $10 million over the Estate Tax Exemption.
Thus, the heirs will pay approximately $4 million in Estate Tax on the $21.7 million inheritance. There are several ways to plan ahead to reduce the amount of taxes paid over the exemption amount. They take time and effort to put in place, so it is necessary to plan ahead. A few include making charitable donations, establishing a family limited partnership and setting up an irrevocable life insurance trust.
Making charitable donations can be completed in a couple ways. You can set up a charitable lead trust, which has your asset generate financial support to a charity for a specific amount of time or when you die. When the time, or you, have passed, your named beneficiaries will inherit the asset. Another way is to set up a charitable remainder trust, which works opposite. The asset is placed in a trust and the income from the asset is paid to the grantor or a named
beneficiary and upon your death or specific term of time, the asset goes to the charity.
Establishing a family limited partnership is a bit more complicated and requires a lot of planning mixed with a lot of trust that your family members will be on board with the life time of the plan. There are advantages and disadvantages that must be weighed before taking on the task of setting up a family limited partnership. For instance, you can transfer lower cost basis assets that grow significantly over time to the partnership, which will reduce your estate assets at death. The negative is the family member receiving the assets could be exposed to a significant capital gain. This may be a lower tax burden than the estate tax, but your CPA should run an analysis to determine if this is the right strategy for you.
Finally, setting up an irrevocable life insurance trust (ILIT) is one of the easiest ways to protect against the estate tax. An ILIT provides a few protections. One is to exclude the benefit from your total estate for estate tax exemption purposes which can be used to offset any amount your heirs may need to pay on the amount over the exemption in your taxable estate. Another protection is for the heir receiving the life insurance benefit as it is directed into the irrevocable
trust and not accessible by the heir’s creditors. Finally, the ILIT provides for an heir who is a minor or an adult with issues handling their finances.
Although only the top one percent of the United States population need to be concerned about the Estate Tax Exemption, it is good for everyone to understand as it is subject to change.