What is the Estate Tax?

The estate tax is a tax on the transfer of property after a person’s death. Generally, it is determined by applying the estate tax rate to a person’s taxable estate. The taxable estate is calculated by determining a person’s gross estate which includes the fair market value of assets owned at death minus certain deductions. “Fair market value” is the price that a willing buyer and seller agree to sell and purchase an asset in an open market. Assets typically included in determining the taxable estate include cash and securities, business interests and real estate. There are no limitations in deductions to the gross estate on the value of property gifted to a surviving spouse known as a “marital deduction” or a qualifying charity known as a “charitable deduction” to minimize the taxable estate. Mortgages and other debts owned by a decedent can also be deducted from the gross estate to determine the taxable estate.

Filing an estate tax return is oftentimes not required unless the value of a decedent’s taxable estate exceeds $11,700,000 (or $23,400,000 for married couples) known as the “Lifetime Exemption.” While a person whose estate exceeds the Lifetime Exemption amount may be able to gift it outright to a surviving spouse, this tactic simply delays payment of the estate tax but does not eliminate the estate tax due upon the death of that surviving spouse.

Proposed Estate Tax Exemption Changes

The American Families Plan (the “Plan”) proposed by President Joe Biden makes several changes to tax laws including the amount of the Lifetime Exemption. Under the Plan, the current Lifetime Exemption will be reduced to $5,000,000 per person (or $10,000,000 for married couples) and adjusted for inflation to $6,000,000 per person (or $12,000,000 for married couples). This change is proposed to become law effective January 1, 2022.

What Does This Mean for You?

The Plan may affect certain individuals and families or none at all. For example, let us assume that a person has already used $700,000 of their current Lifetime Exemption, and therefore, has $11,000,000 in Lifetime Exemption remaining. Further assume that they have a gross estate of $21,700,000 and makes a $11,000,000 charitable gift (which does not count towards a Lifetime Exemption), leaving a taxable estate of $10,000,000. If that person passes away in 2022 when the Lifetime Exemption is decreased to $6,000,000 then $4,700,000 of their $10,000,000 taxable estate would be taxed at the 40% estate tax rate resulting in $1,880,000 of estate tax due.

Conversely, using the same facts as above, if this person gifts the $10,000,000 remaining in their Lifetime Exemption prior to enactment of the Plan, the estate tax due will be significantly decreased resulting in a zero taxable estate. They reduce the remaining $4,700,000 of their taxable estate being exposed to estate tax of 40% resulting in savings of $1,880,000 through careful and tactful planning.

Again, whilst the provisions in the Plan are proposed policy changes, it can greatly affect wealth that is passed from one generation to another. The use of irrevocable trusts as a method of gifting assets to loved ones and heirs can be greatly impacted by this policy. It is important to consult with an experienced estate planning attorney whom you trust. At Waugh PLLC, we have experienced tax attorneys who are experts in tax law that can help with your estate planning needs. Please contact info@waughgrant.com to schedule a consultation today.