Tax Planning Techniques to Reduce Your Exposure to Estate Tax

There have been dramatic changes in the estate tax laws over the last twenty years. After the recent elections additional estate tax reform is a distinct possibility. Currently, each person can give away during lifetime, or distribute at death, an amount of $11.7 million without being subject to federal estate tax. That high exemption amount may change under the current administration. Now is the time for us to discuss reducing or eliminating your exposure to estate tax.

In 2001, the amount a person could gift during lifetime or transfer at death without being subject to estate tax was $675,000 (known as the lifetime exemption). The top estate tax rate was 55%. In 2010, the lifetime exemption was increased to $5 million, subject to inflation increases and the rate was dropped to 35%. The tax rate increased to 40% in 2013 and the rate has remained at 40% ever since. Under the Tax Cut and Jobs Act of 2017, each person has an exemption of $11.7 million. This exemption will drop to $5 million when the Act expires in 2026 unless the laws are changed prior to that time.

Another important aspect to estate planning is the basis adjustment. When certain assets are included in a person’s estate, those assets receive a new basis equal to the market value at the date of death. Annuity accounts and retirement plans are exempt from this rule.

During the campaign Biden proposed to reduce the estate tax exemption to $3.5 million and to increase the top tax rate to 45%. The campaign also proposed to eliminate the basis adjustment. It is not clear whether the tax plan would result in pre-death capital gains being realized and thus the capital gains would be paid at the time of the persons death. Or, if the beneficiary inherits the carryover basis and recognizes the capital gain when they sell the asset. In either case, the combination of the lack of step up in basis and the lowering of the lifetime exemption would have a dramatic tax affect.

One of the simplest estate tax planning techniques is to make gifts without using your estate tax exemption first. The gift tax annual exclusion allows any person to gift to any other person up to $15,000 each year without utilizing any tax exemption. Additionally, a person can gift up to 5 years of annual exclusion to create a 529 plan (Account which is a specific type of college savings account) without utilizing any estate tax exemption. Taking advantage of that rule would allow a single individual to fund $75,000 for a college savings account and a married couple could fund 150,000 for a child or grandchild. Further, a person can pay certain college and medical expenses directly to a third party and a parent can pay a child’s college tuition directly to the college and make an annual exclusion.

Another technique is to make large taxable gifts. The IRS has confirmed that if a person makes large gifts, and the exemption amount is reduced later by a law change to an amount that is lower than the value of the previous gifts, those gifts would be grandfathered, and no tax would be due. However, there is a possibility that if the tax law is changed in 2021, it could be retroactive to January 1. Given the environment that we are in and the exemption will be reduced in 2026 if nothing happens before then and the fact that the current administration may choose to lower the exemption before then, the exemption should be used, or it will be lost. However, large gifts are a high-risk, high reward planning opportunity. If it appears that any estate tax laws will be passed this year, there will be a huge rush to make large gifts towards the end of 2021.

Individuals may seek to retain the possible benefits from gifted property, through the execution of various trusts, including spousal lifetime access trusts, spousal lifetime access non grantor trusts, dynasty trusts, domestic asset protection trusts, and special power of appointment trusts.

For large estates, individuals may seek to reduce exposure to the elimination of step up in basis to recognize gains before death to avoid the potential 39.6% tax rate on capital cans exceeding $1 million, which was also mentioned on the campaign trail. This could be accomplished by charitable trusts, tax free exchanges, charitable contributions of appreciated property, and installment sales to non-grantor trusts.  Also, individuals may seek to transfer future appreciation by using grantor retained annuity trusts and split purchase annuity trusts. These techniques are further enhanced by the current low interest environment.

Given the potential for significant changes in tax policy in 2021, individuals are encouraged to review their current tax situation with our tax and wealth management professionals. Unfortunately, the trajectory of the tax policy and changes in tax policy will not become clear until sometime in 2021. As a result, individuals should review individual tax and estate planning at this time so that an informed decision can be made if necessary.

If you are interested in learning more about estate tax planning, contact your trusted advisor or start here.


Diversification and asset allocation do not ensure a profit or guarantee against loss.

The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

The views expressed are those of BerganKDV Wealth Management. They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm. Investment advisory services and fee-based planning offered through BerganKDV Wealth Management, an SEC Registered Investment Advisor.

CATEGORIES: Wealth Management
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