3 Tax Issues to Consider in Estate Planning – Estate Taxes

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The new year brings uncertainty surrounding the estate tax. The 2017 Tax Cuts and Jobs Act (TCJA) expires on December 31, 2025, and as a result, the historically high estate tax exemption is scheduled to revert back to pre-TCJA levels. If nothing changes, the exemption will be cut in half for people who pass away in 2026. With the shifting tax laws, it’s an optimal time to understand the estate tax – what is it, who does it affect, and what can you do to minimize your estate tax liability?

What are Estate Taxes?

The estate tax is assessed by the federal government (and some states) at the time someone dies on the net value of his or her estate. A decedent’s gross estate includes real estate, personal property, investments, cash, business interests, and even proceeds from life insurance policies. Deductions from the gross estate include funeral expenses, debts owed by the deceased, charitable contributions, and transfers to a surviving spouse. The resulting amount (gross estate minus deductions) is the taxable estate. The taxable estate is subject to the estate tax at a rate of 40% for amounts above the exemption.

Who is Affected by the Estate Tax?

The estate tax only applies to taxable estates that exceed the exemption. For 2025, the estate tax exemption is $13.99 million per person (or almost $28 million for married couples). Under current law, the estate tax exemption will decrease to about $7 million per person beginning January 1, 2026.

The fiduciary managing the estate, usually the Trustee of a Trust or Executor of a probate estate, is responsible for filing an estate tax return and paying any taxes owed. If the estate consists of illiquid assets, Trustees or Executors will need to sell property and business interests at inopportune times to cover the tax liability. As a result, what you intend to leave to your beneficiaries may not be what (and how much) they actually inherit.

Planning Opportunities

For those who anticipate a hefty estate tax bill, the time to plan is now. The key to minimizing estate taxes is to reduce the size of your taxable estate by either reducing your gross estate or increasing deductions.

Lifetime gifts. Lifetime gifts not only remove the gifted amount from your estate, but making gifts also removes any post-gift appreciation. For example, if you gift your child a property valued at $1 million at the time of the transfer, the property and any future appreciation are removed from your estate. If the property is valued at $3 million at the time you pass, then the entire $3 million is no longer part of your taxable estate.

While lifetime gifts reduce your taxable estate, making outright gifts may not be the most strategic way to minimize taxes. Not only do lifetime gifts affect the donee’s income taxes upon the sale of gifted assets (see this article regarding income taxes on gifted assets), but the amount you give away can reduce your estate tax exemption. The federal gift and estate taxes are unified, which means that the value of wealth transferred during life and at one’s death are combined. If the combined amount exceeds the estate tax exemption, estate taxes are due. Consequently, the amount you give away during your life can reduce the amount you can give away tax-free when you pass.

For example, suppose Fred gifts $3 million in 2020. He then passes away in 2025 with a taxable estate of $12 million. The lifetime gift reduced Fred’s exemption by $3 million. Instead of $13.99 million exemption, only $10.99 million ($13.99 million minus $3 million) remains. As a result, $1.1 million ($12 million – $10.99 million) will be taxed at the applicable rate.

Donors are required to file a 709 gift tax return each year they make gifts that exceed the annual gift tax exemption. The IRS keeps track of your remaining estate tax exemption by reducing the available exemption by the amount of lifetime gifts reported on 709 returns. Gift tax returns do not have to be filed for gifts valued at less than the annual gift tax exemption. Accordingly, such gifts do not count against your available estate tax exemption.

Many of our clients prefer to avoid outright gifts to their beneficiaries. Donors often prefer to maintain some degree of control over the ultimate disposition of gifted assets. In such situations, gifts to irrevocable trusts are superior to outright gifts (learn more about dynasty trusts, education trusts, and SLATs).

Charitable gifts. Estate tax liability can also be minimized by increasing deductions. Maximizing charitable contributions reduces your taxable estate while benefiting a charity you believe in. Testamentary gifts to charities can be made through vehicles such as donor-advised funds or charitable trusts. Charitable trusts have the additional benefit of preserving an annuity interest to the donor for a specific term.
Irrevocable Life Insurance Trusts (ILITs). An ILIT is an irrevocable trust that owns a life insurance policy. Placing the policy in an ILIT rather than owning it yourself avoids the inclusion of the proceeds in your taxable estate. The Trustee of the ILIT can use the proceeds of the policy to pay estate taxes, which are generally due nine months after the date of death. As mentioned above, estates largely comprised of real estate or business interests may be forced to sell when the market is down to avoid penalties imposed on late tax payments. ILITs provide a means to make cash available to heirs without adding the proceeds of an insurance policy to the taxable estate.

Conclusion

There is still time to put a plan into place to minimize your estate tax liability. Such planning often involves a team of professionals such as attorneys, CPAs, financial advisors, and appraisers. If you are thinking about implementing a strategy to reduce your taxable estate, start now and talk to your team today before their calendars are booked.

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Tiffany Chiu

Tiffany K. Chiu is a Partner at Modern Wealth Law, APLC. Tiffany is a skilled bilingual (Mandarin and English) estate planning attorney who caters to the needs of individuals, families, and small business owners in Orange County. She has extensive experience in drafting documents related to formation, financing, reorganization, conversion, and dissolution of joint ventures, partnerships, limited liability companies, and corporations.

By Tiffany Chiu | Posted on January 7, 2025