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When you are creating your holiday shopping list, estate planning probably isn’t on your radar. But if you have a larger estate or valuable heirlooms, maybe it should be. Learn how you can use holiday gifts to roll out your estate plan and help your loved ones avoid surprises later on—updated as of December 2020.
Most people don’t realize how large their estate really is. Your physical assets like your home, car, vacation property, and all your furniture can quickly add up to hundreds of thousands of dollars in assets after your death. Depending on just how big your estate grows, those big-money items could tip the scales and create estate tax consequences for your loved ones in the future.
Right now, estate taxes only apply to the largest estates. Of the 2.7 million people who died in the U.S. in 2018, less than 0.1 % ended up paying estate taxes. That is because, in 2017 the federal government passed the Tax Cuts and Jobs Act, which increased the federal estate tax exemption to $10 million plus inflation.
If you were to pass away in 2020, the first $11.58 million would pass to your heirs’ tax-free. (For married couples this number is $23.16 million.) Everything beyond that threshold is subject to a tax of up to 40% of the estate. Of course, that’s $11.58 million all told; It includes everything from the investment accounts to the silverware.
That high tax exemption threshold probably isn’t here to stay. Nearly all of the estate tax changes in the Tax Cuts and Jobs Act will automatically expire after 2025 unless the federal government decides to extend it. If you pass away on January 1, 2026, the estate tax exemption will drop back to the pre-2018 level of $5.6 million (as adjusted for inflation). For middle- to upper-class families, even if the government does nothing in the meantime, that sudden sunset provision could mean that their heirs will face a sudden surprise as the estate tax law springs back to a much lower exemption threshold.
President-Elect Joe Biden’s tax plan proposes various types of tax increases, including an increase to estate taxes. The proposal calls for reducing the tax-free amount of the estate that can be left to $3.5 million for individuals and $7 million for couples, as well as increasing the top marginal estate tax rate to 45%.
Whether or not these proposals will come to pass depends on many factors we can’t predict, but most obviously on the results of the runoff elections for the Georgia senate races. If Democrats win both elections, control the presidency and both houses of Congress, we believe it’s likely that at the very least the estate tax exemption will return back to pre-2018 levels ($5.6 million + inflation per person) sooner than 2026. It is also certainly possible that the President and Congress would reduce the exemption all the way back down to $3.5 million, as Joe Biden has proposed.
The bottom line is that if future legislatures decide to lower the estate tax exemption or increase the tax consequences for your tax bracket, your family could be the ones facing a bill your estate plan didn’t anticipate. On the other hand, if Republicans retain 51 senate seats, we believe changes prior to 2026 are unlikely.
There is no federal constitutional prohibition on a retroactive tax increase, so it is possible that Congress could vote to increase estate tax rates and reduce the amount of the estate tax exemption for 2021, even though a law doing so won’t be passed until after the start of the year. Given the fact that the Georgia senate races are still up in the air and will not be decided until 2021, this would be particularly unfair this year. Our guess (and it’s just a guess!) is that the federal government will focus on the pandemic in 2021. Any potential tax increases are more likely to occur in 2022 or later, depending on the state of the economy and political climate.
It’s important to understand that the gift and estate tax are unified. This means that what the IRS calls “taxable gifts” you make during your lifetime reduce the amount which you can leave estate tax free when you pass away. There are various exceptions as to what counts as taxable gifts, but the two simplest are that gifts between spouses generally will not count and that you can generally give $15,000 per person, per year.
Even though they are called “taxable gifts,” you don’t have to actually pay any gift tax until you make lifetime taxable gifts over the current $11.58M limit (or whatever it ends up being reduced to). Lifetime gifts to irrevocable trusts can provide a great way to leverage the use of the available exemption, but you have to make sure you make them before the law changes and the limit falls.
That’s why many families with larger estates should use annual or large, one-time financial gifts as part of their estate plan. These gifts to children and grandchildren spend down family investments and savings, avoiding large estate tax consequences after they pass away. Annual gifts to an irrevocable trust or trusts are often the best way to structure this gift. The amounts are decided strategically taking into consideration:
If you are worried that your estate could bump up against the estate tax exemption now, or in the future, talk to your estate planning attorney now to decide if annual financial gifts or a large gift to an irrevocable trust may be the answer. In future posts, we’ll explore some potential strategies in more detail.
The wealthy aren’t the only ones who can use holiday gifts as part of their estate plan. Sometimes the most important parts of a person’s estate are physical rather than financial. Families of more modest means can use strategic holiday gift-giving to protect family valuables and heirlooms.
When someone without substantial investments passes away, sometimes their final expenses can eat up or even exceed their financial assets. Some debts become uncollectible when you pass away, but if you don’t have enough to cover your funeral, burial, final medical expenses, or other collectible debts, it could put your executor in a tough spot when deciding whose keepsake gets sold to pay those debts.
One way to protect your family heirlooms from debt collectors is to give them away to your loved ones while you are still alive. This can also cut down on family conflict when you pass away because debates over heirlooms of little monetary value are often the biggest source of disagreement. The holidays are a great time to pass on family valuables.
Thanksgiving, Christmas, Hanukkah, and other winter holidays often include family get-togethers and gift-giving. If you and your estate planning attorney have worked out who will receive your most prized assets, you can create a memorable holiday by giving your grandmother’s wedding ring or the family silver as holiday gifts and telling their story around the dinner table.
Whether you are using holiday gifts to avoid estate tax or creditors, protecting your assets requires a careful understanding of probate and tax law issues. If you want to make sure your heirs receive what you intend, you should discuss your holiday gift-giving with an experienced estate planning attorney to make the most of what you have.
At Harrison Estate Law, we can help you build a complete estate plan that includes strategies to make the most of your assets. We are happy to help you with setting up a new estate plan or to review and update an existing plan. We will lay out a strategy for annual financial gifts and passing on heirlooms to avoid handing over more of your assets to the IRS or creditors than you have to. Please contact us online or via email or call 352-559-9828 to schedule a free consultation. If you don’t live close to Gainesville, we are happy to set up a phone or Zoom call.
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