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Advisor Perspective

Advisor Perspective

The Estate Tax Exemption Explained and What the Future Holds

Marcus Velasco

Advisor, CPWA®, CFA, CFP®
Marcus enjoys sharing the tools and resources, as well as his experience, that help clients build and stick with their financial plans. Clients know they can count on him to face important decisions in life with confidence and clarity.

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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.

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