1. Take Advantage of the High Exemption While It Lasts

Historically, the exemption amount has risen consistently every year since the federal estate tax reform in 1976. Many of the increases were modest adjustments for inflation, but other times the amount increased considerably. For example, in 2011, the exemption went up from $1 million to $5 million, and 2018 saw the amount jump from $5.49 to $11.18 million.

But that nearly fifty-year pattern is soon to change. The 2018 adjustment was only temporary, and under current law, it will reduce by 50% (adjusted for inflation) on January 1st, 2026.

This means that high-income taxpayers have a historic window of opportunity to anticipate the lower exemption amount and reduce future transfer taxes.

To utilize the exemption now and lock in substantial tax savings under the current, higher amount, transfer your assets in the form of charitable gifts made during life. You will not owe gift tax on gifted funds until they exceed the exemption amount, after which point you can still gift up to the annual limit of $15,000 each year.

You also place the gifted assets outside of your taxable estate by transferring assets during your lifetime, where they will accrue appreciation separately. This can lessen the taxation of the assets even further.

2. Review Life Insurance Policies

Life insurance benefits paid out upon death are not usually subject to the estate tax, although there are two exceptions: 

  • The whole amount of the benefit is included in the estate, and the estate is named as beneficiary.
  • The whole amount of the death benefit is included in the estate, and the decedent (the person who passed away) both owned and was insured by the policy on the date of their death.

The second situation is more likely, as beneficiaries are usually individuals, but the estate will be taxed on life insurance benefits in either case. 

Of course, the life insurance policy owner does not need to be the same person whose life the policy ensures. That means if the decedent did not own the policy, then the proceeds do not count as part of their estate and are therefore not subject to the estate tax. 

If you own life insurance on yourself, it may be worth changing ownership of the policy as part of your estate planning. The IRS considers the transfer of the policy in this context to be a gift, and it removes the death benefit from the estate so long as the original owner lives for three years past the transfer. 

Additionally, if much of your estate comprises illiquid assets, such as real estate or businesses, the liquid assets may not be enough to cover the tax bill. A good life insurance policy can help cover most of the cost and cushion the burden for your beneficiaries. 

To ensure you are getting the most benefit possible from your life insurance policies, make sure they are all paid and have not lapsed. You may also consider selling the policy to an irrevocable life insurance trust (ILIT) or even stopping or reducing payments if the cash value is sufficient.

3. Use the Marital Deduction

The unlimited marital deduction allows an individual to transfer an unrestricted amount of assets to a spouse tax-free, either during life or upon death. This does not exclude the assets from taxation forever but does postpone tax on them until the death of the recipient spouse. 

Non-citizen Spouses

Take note: if the spouse is not a U.S. citizen, the marital deduction does not apply. Still, a taxpayer is permitted a higher annual exclusion for gifts to a non-citizen spouse ($164,000 in 2022). 

There are some exceptions. Assets passing to a non-citizen spouse upon death do qualify for the marital deduction if:

  • The assets pass to the spouse in a qualified domestic trust.
  • The spouse is a U.S. resident who becomes a U.S. citizen before the due date for the estate tax return. 

If a marital deduction is not allowed, and the surviving spouse’s estate is later subject to U.S. estate tax, the surviving spouse’s estate receives a credit for tax paid on the first spouse’s death. 

4. Establish a Family Limited Partnership

Creating a Family Limited Partnership (FLP) is a common but powerful method for transferring business ownership from one generation to the next. It can also help reduce estate value while protecting against asset loss. 

An FLP is essentially a holding company where the Limited Partners are family members or heirs. As a General Partner, this type of entity allows you to maintain control over the management and distribution of the assets while shielding the assets from creditors and reducing gift and estate taxes. 

Upon your death, control of the assets transfers to the Limited Partners — your beneficiaries, who receive a break on the estate, gift, and income taxes for the assets they now manage.

If properly executed, gifting portions of your estate to your heirs through an FLP during your life can have notable advantages. For example, it may be possible to pass 115-130% of the value of your exemption to your heirs while entirely avoiding estate taxes. 

As icing on the cake, once the transfer is complete, any growth in the value of the assets is free from estate taxes, too. 

5. Don’t Forget About State Estate Taxes

If the net value of your estate is lower than the current federal exemption amount, that doesn’t necessarily mean you are not exposed to state-level estate taxation. Although many states do not impose state or inheritance taxes, some do, and in some cases, the estate tax liability can be surprisingly high. 

While only eleven states have an estate tax alone, seventeen states and the District of Columbia may tax your inheritance, estate, or both. This graphic from the Tax Foundation breaks down which states levy one or both kinds of taxes and the rates and exemption amounts for each state. 

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