Estate Planning with Uncle Sam

One of the basic goals when planning your estate is to minimize to the extent possible any money due to the federal government, thereby maximizing your future beneficiary’s inheritance.

Tax planning for large estates can utilize various different avenues in order to maximize the estate and can get quite complex. Generally, estate tax planning on this level requires an estate planning attorney with advanced tax experience and training, or the inclusion of a tax professional or CPA to work with an estate planning attorney. 

However, for those of us who don’t find ourselves in the 1%, there are some basic federal tax implications that you should be aware of when planning your estate. There are generally three federal transfer taxes to consider. These include estate taxes, gift taxes, and generation-skipping transfer taxes (GST). These three federal taxes could impact how much of your estate passes to your beneficiary’s and how much Uncle Sam gets to keep.

Estate Tax:

Federal estate taxes are based on the value of your taxable estate at the time of your death. As you may have heard in the last couple of years, the exemption (amount you can transfer without having to pay any tax) has increased exponentially. In the 1990’s the exemption never rose above 1 million dollars, capping at 650k in 1999. By 2010 that number rose to 5 million, increasing incrementally each year to just under 5.5 million in 2017, before making a huge jump in 2018 to over 11 million dollars! As of 2021, the federal estate tax exemption is at 13.61 million.

Now you may ask yourself how this applies to your average family. Well, this huge jump is not favored by the current administration, who may elect to reduce that amount soon, and the huge jump that occurred in 2018 is slated to expire (or “sunset”) in 2025, reverting back to the pre-2018 amount. Although it may not directly affect you if you died tomorrow, it is one tax you should keep an eye on.

Gift Tax:

The federal gift tax is imposed on gifts you make during your lifetime, also subject to the 13.61 million exemption amount. The underlying reason behind the gift tax is to prevent tax payers from avoiding the above estate tax by gifting any of their estate over the exemption amount before they die. There are additional annual exemptions for gifts, 18k per individual per year, that do not count against the 13.61 million. Therefore, someone can reduce their estate by making 18k gifts each year, including multiple 18k gifts. There are some additional exemptions for gifts to spouses, charity, and to pay medical and educational expenses to consider as well. Any gift tax exemption used that counts toward your lifetime exclusion will reduce your total exemption for estate tax after death. 

Generation-Skipping Transfer Tax (GST):

Finally, we have the GST tax, which is again created to prevent avoidance of final estate tax after death. The general idea is that an individual could decide (in an attempt to avoid some estate tax) that instead of giving their estate to their children, thus paying estate tax, who then give it to their children (grandchildren of the original estate), requiring a second estate tax payment, the original estate owner instead transfers the estate directly to their grandchildren, avoiding the middle generational transfer and one round of estate tax. There are some exemptions to consider for this type of transfer, however, the consequences of doing this wrong could end up requiring an additional tax at the highest federal estate tax rate of 40% in 2024. This includes beneficiaries who are much younger as well and is not limited by generations of beneficiaries related to you. You should absolutely consult with an experienced tax advisor before attempting any such transfer. 

In the end, and especially over the last few years, most people are unlikely going to be impacted by the above taxes. Even if you fall well below the current threshold now, you should be aware of the above tax implications when planning your estate. Individual states may also impose their own taxes similar to those above, which may be deductible on your federal estate tax return, but is something to be wary of. 

Tax law is constantly changing – our current laws are set to change yet again in 2025 – and everyone’s situation is different. The right choice for your friend or family member in a similar situation may not apply to your situation. Before making any decision regarding your estate and tax planning, you should consult with your Attorney to help make the best decision based on your individual circumstances.