Understanding the Estate Tax Exemption: What’s Changing and What You Need to Know
As estate planning continues to evolve, understanding the intricacies of the federal lifetime estate and gift tax exemption becomes increasingly important. Changes to this exemption could significantly affect the tax liabilities of high-net-worth individuals, especially as we approach 2026. This article explores how the estate and gift tax exemption works, potential changes on the horizon, and strategies for planning accordingly.
What Is the Federal Lifetime Estate and Gift Tax Exemption?
The estate tax is applied when an individual’s estate surpasses a certain value threshold. This includes not only the value of the estate upon death but also any taxable gifts made during the individual’s lifetime. A gift becomes taxable if its value exceeds the annual gift tax exclusion, which is $18,000 for 2024. If a donor gives more than this amount to a recipient, the gift becomes taxable, requiring the donor to file a Form 709.
The lifetime estate and gift tax exemption allows individuals to transfer wealth without incurring estate or gift taxes up to a specified amount. For 2024, the exemption is $13.61 million for individuals, which is doubled to $27.22 million for married couples. This exemption amount also allows for the transfer of unused portions of a deceased spouse’s exemption (known as the deceased spousal unused exclusion, or DSUE).
However, if the total value of an estate and lifetime taxable gifts exceeds the exemption amount, the excess is subject to a 40% estate tax. For example, if an individual has an estate valued at $10 million and has made $5.61 million in taxable gifts during their lifetime, their estate would be taxed on the $2 million exceeding the exemption.
What Changes Are Coming in 2026?
The tax landscape surrounding estate and gift exemptions is about to change. The provisions of the Tax Cuts and Jobs Act (TCJA), passed in 2017, temporarily doubled the estate and gift tax exemption limits. However, these provisions are set to expire in 2026, which could drastically reduce the exemption amounts, potentially halving the current levels.
This reduction would mean that estates valued above approximately $6 million could face significant estate taxes, which could increase the tax burden for many high-net-worth individuals. Additionally, the generation-skipping transfer (GST) tax exemption, which allows tax-free transfers to descendants who are two or more generations removed, would also revert to lower levels. This could mean higher tax obligations for families looking to pass wealth down multiple generations.
Planning for the Estate and Gift Tax Exemption Sunset
While it’s not certain what will happen in 2026, it’s critical to prepare for the possibility that the exemption will be reduced. Estate planning professionals advise clients to take proactive steps now to minimize potential tax liabilities. The best strategy is to prepare for multiple scenarios, considering both the current exemption amounts and the possibility of a reduced exemption in the near future.
For example, if an individual’s estate is valued at $10 million in 2024, they would owe no estate taxes under the current exemption of $13.61 million. However, if the exemption decreases to pre-TCJA levels in 2026, that same individual could owe taxes on almost $3.2 million of their estate. Without proper planning, this could result in a significant tax burden, potentially diverting over $1 million from intended heirs.
The Importance of Liquidity in Estate Planning
When preparing for potential estate taxes, ensuring sufficient liquidity to cover any tax liabilities is essential. Without enough liquid assets, beneficiaries may need to sell estate assets—such as real estate or other valuable property—to pay taxes. This could lead to delays or complications in the asset distribution process, especially if the assets are difficult to liquidate.
Proactively addressing the payment of estate taxes, whether through life insurance, liquid assets, or other means, can help ensure that heirs receive the full benefit of the estate, without needing to liquidate significant assets or face financial difficulties.
Conclusion
As we approach 2026, the estate tax exemption is poised for a substantial reduction unless new legislation is passed. The potential for this change underscores the importance of reviewing and updating your estate plan now. With proper planning, you can ensure that your wealth is passed on efficiently and with minimal tax liabilities, regardless of what happens in the years ahead.
