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By: Charles Avalli
Taxes.
Nobody likes dealing with them. However, they become especially relevant and important when planning your estate.
Being aware of the applicable federal and states taxes that will be due can have an immense impact on what will remain to be distributed to your family and other beneficiaries. With taxes in mind, everyone needs to be familiar with the “unified credit”, which is the amount each individual can leave free of tax, upon death, to a non-spouse under federal estate taxes. Let me fill you in on this.
This amount is very important as every dollar which exceeds the unified credit is taxed at an exceptionally high federal estate tax rate of 40% (yes, you read that correctly, 40%). Additionally, this amount is also “portable” between spouses. This means that any portion that is not used by the first spouse upon death, the remaining amount “ports” or transfers to the surviving spouse to be added to that spouse’s unified credit which effectively increases the amount which may pass that second estate free of federal tax.
To illustrate how this works, let’s say there is a married couple, and Husband dies first with $7,000,000 in his estate, with the current unified credit amount being $12,920,000. Since Husband is under the exclusion amount, the entire $7,000,000 is not subject to federal tax. The “unused” $5,920,000 passes to his surviving spouse who now has an increased amount of $18,840,000 which may pass through her estate (as opposed to the original $12,920,000) excluded from federal estate tax.
Over the last number of years, the unified credit amount has been changing annually as it is indexed for inflation. However, it is likely to have a major change at the end of 2025. Prior to the Trump Tax Reform Act of 2017, the exclusion amount was set at $5,000,000 (adjusted annually for inflation). This all changed with the Trump Tax Reform Act that went into effect in 2018. Amongst the myriad of changes that Act made to the Federal Tax Code, the bill made a drastic increase to the basic exclusion amount doubling the amount from $5,000,000 to $10,000,000 and thereafter adjusted for inflation. As a result, it has grown to $12,920,000 for 2023. This huge increase in the exclusion drastically changed estate planning strategies, especially for high-net-worth individuals who also now can take advantage of portability of the exclusion between spouses.
This increase is not permanent as the statute contains a “sunset provision” which limits the increased amount to be in effect until December 31, 2025. This is a problem that Congress, and the President (however then constituted) will need to confront in the months before December 31, 2025. Absent the passing of new legislation renewing or extending the substantial changes to the unified credit, the amount of the unified credit will “sunset” and revert to the previous $5,000,000 amount.
Although we are still in 2023, December 31, 2025 will come much sooner than we think. It is advisable for high-net-worth individuals to be proactive and start to contemplate changes to their estate plan to protect themselves, their family and assets from the heavy burden of federal estate taxes.