The Estate Tax Exemption Explained and What the Future Holds
After a lifetime of hard work and diligently paying your taxes throughout your working and retirement years, you may be surprised that when you plan for your legacy, a portion of your estate may be subject to the estate tax. But what is the estate tax? How does it apply? And how might it change going forward?
The Estate Tax and Exemption Explained
The IRS defines the estate tax as a “tax on your right to transfer property at your death.” While that sounds a bit ominous, the federal government provides an estate tax exemption which significantly lowers the number of people subject to the estate tax. This means taxes are only due on the portion of an estate above the exemption amount. The current federal estate tax exemption is $12.92 million for 2023, a number that is adjusted for inflation each year. The actual federal estate tax rate is progressive but quickly climbs to 40%.
How Does it Apply?
The estate tax is best explained through example: Suppose an individual, through a lifetime of hard work, saving and investing, passes away with a net worth of $15 million – their net worth being the sum of all their assets (homes, investment accounts, retirement accounts, personal belongings, etc.) less the sum of all their liabilities. The first $12.92 million is exempt from federal estate taxes, meaning the remainder ($15,000,000 – 12,920,000 =) $2,080,000, will be subject to the estate tax. This would result in $832,000 of federal estate taxes.
Married couples can use the concept of “portability”, allowing them to give their spouse any unused portion of the exemption. Functionally this means a married couple has $25.84 million (or two times $12.92 million) exempt from estate taxes, if properly planned. Any estate tax due is generally not determined until the passing of the second spouse.
What the Future Holds
The estate tax has a long history of being adjusted, much more frequently than income tax rates. Under current law, the $12.92 million will continue being adjusted for inflation until 2026. At that point, as part of the expiration of the 2017 Tax Cuts and Jobs Act, the exemption will be cut in half – to just under $6.5 million per person. This is the current law, but there have been recent proposals to adjust the exemption:
- During the most recent presidential election campaign, the current administration proposed limiting the exemption to $3 million and increasing the maximum estate tax rate to 45%.
- The Build Back Better Act of 2021 proposed reducing the exemption to $5 million in 2022.
State Estate Taxes
In addition to the federal estate tax, 13 states levy estate taxes at the state level, usually with exemptions significantly lower than the federal exemption. There are also six states that levy a tax on inherited assets, including one state that has both. This leaves more than 30 states which do not tax individuals at death, which includes many popular retirement states.
Planning Opportunities to Reduce Your Estate Taxes
Fortunately, there are several planning tools that can be used to help reduce the impact of estate taxes on your legacy. These include lifetime giving, charitable contributions, the use of trusts and other advanced planning techniques, which will be covered in a future article.
Please reach out to your JMG Financial Group Advisor for additional information on maximizing the value of your legacy. Feel free to share this article with someone who may find it helpful.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by JMG Financial Group Ltd. (“JMG”), or any non-investment related content, made reference to directly or indirectly in this writing will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this writing serves as the receipt of, or as a substitute for, personalized investment advice from JMG. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. JMG is neither a law firm, nor a certified public accounting firm, and no portion of the content provided in this writing should be construed as legal or accounting advice. A copy of JMG’s current written disclosure Brochure discussing our advisory services and fees is available upon request. If you are a JMG client, please remember to contact JMG, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. JMG shall continue to rely on the accuracy of information that you have provided.
To the extent provided in this writing, historical performance results for investment indices and/or categories have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your account holdings correspond directly to any comparative indices. Indices are not available for direct investment.