Everyone needs an estate plan. And most people prefer the idea of loved ones remembering them in a positive light – not for estate planning missteps.
The Estate Tax & The Marital Deduction
As of 2023, every United States citizen receives an Estate Tax deduction of 12.92 million dollars usable over their lifetime. This credit will offset any estate or gift tax that might be due. Generally speaking, and with some exceptions, assets and taxable gifts need to be close to 12.92 million dollars over your lifetime before any significant estate planning tax liabilities arise. Furthermore, married individuals can coordinate estate tax deductions between spouses, called portability, utilizing the unlimited marital deduction. This combines the total deduction for the two estates and ensures no waste of the combined $25.84 million estate tax exclusion.
The sunset of the Tax Cut and Jobs Act
As the laws currently sit, if you do not have or expect to have at mortality close to these amounts in total assets, many of the more advanced estate planning techniques may be extraneous. Naturally, exceptions apply, for instance, in the event someone has a special needs child.
The estate tax has an adjustment for inflation, which means that in tomorrow’s dollars, the actual deduction at mortality is likely to be much higher. Or laws may change. After December 31, 2025, unless Congress acts to extend the provision, the estate and gift tax exemption will revert to pre-Tax Cut and Jobs Act levels. If sunset, and after an adjustment for inflation on the 2017 exclusion, it might only be around $6M for the individual and $12M for married couples.
If interested, maybe check this spreadsheet if you’d like to explore it in more detail. Please note that we only know the inflation adjustment numbers when the IRS releases them. But, whether or not Congress extends the exemption, the spreadsheet should provide a pretty reasonable idea of an individual’s exposure to estate tax liability. Always work with an estate planning attorney to get a precise idea of any tax liability.
Recommendation: Pros & Cons of Becoming a Real Estate Tycoon
The Federal Estate Tax is a tax on your ‘stuff’ upon death. It generally consists of everything you own or have interests in at the time of death. Your property’s ‘fair market value’ is typically used but not necessarily your ‘basis’ (or what you paid for the asset or the value when acquiring the property). The total of all these items is your ‘Gross Estate’ calculated on IRS form 706. It’s possible the property may include cash, real estate, investment securities, insurance, annuities, or business interests, among other assets. Most notably, the top estate tax rate is 40%.
Using the ‘Step-Up’ as a Planning Technique
In my experience, the “step-up” in basis to the fair market value on real property at the time of death is by far the most dynamic and inexpensive estate planning technique. What’s nice is it’s available to individuals below the $12.92M individual and $25.84M combined exclusion. The “step-up” is one of the very few cases in the IRS code where gains on real property essentially wipe away. There is an art to organizing and fully utilizing potential “step-up” assets upon death. “Step-up” assets get the best of both worlds – the ability to use and then subsequently pass along in a tax-efficient way. A “step-up” in basis can benefit larger estates as well.
Those that have enough to cover income needs and additionally have taxable accounts outside of their retirement accounts that they don’t expect to use, get to enjoy the deferral of tax on those assets as they appreciate. Furthermore, their heirs may enjoy a ‘stepped up’ basis at the time of death, wiping away all those gains. Not a bad deal!
The Non-traditional Family Arrangement
Nowadays, the American family gets to enjoy quite a bit of diversity. Divorce and remarriage are commonplace. Blending children into new families, adoption, domestic partnerships, and same-sex marriage arrangements offer unique estate planning considerations. Marriages among non-U.S. citizens offer their own unique challenges when it comes to estate taxes and techniques mentioned above.
Also, under state law, an unmarried partner is typically not considered a family member. I’ll sometimes suggest a”cohabitation agreement.” Clarifying a living arrangement, should the property owner suddenly pass away or be incapacitated. Your rights as a partner are not nearly as strong as the rights of a spouse. This can create unexpected complications regarding living situations and healthcare decisions.
Partners should implement durable powers of attorney for health care (DPOHC), allowing the other partner to make important decisions on their behalf should they become incapacitated. Additionally, domestic partners should consider implementing a ‘cohabitation agreement’ to address their estate planning discrepancies.
Preparing for Medical and End-of-Life Care
Traditionally a Living Will and a durable power of attorney for health care (DPOAHC) apply to individuals who are unable to provide consent regarding certain medical decisions. These documents intend to provide a clear statement of procedures. As well as individual consent regarding specific medical circumstances. As such, the selected surrogate is a key piece to the success of these documents.
For example, the Advanced Health Care Directive replaces California’s Durable Power of Attorney for Health Care. It is now the legally recognized document for appointing a healthcare agent. Why? The AHCD offers more flexibility than the standard DPAHC. It also does not expire.
Just Do Something
Sometimes all that’s necessary is clarity about where the money should go. For instance, transferring highly appreciated securities or switching bank accounts into a trust can take time. Above all, a trust likely needs to be done, but alternative beneficiary designations can help get something in place. These might include a Transfer on Death (T.O.D.), Payable on Death (P.O.D.), and Transfer on Death of Real Property. It’s not always clean or available in every state. Also, I must hedge and warn clients about potential limitations or the proven ability of some alternative beneficiary designations.
401Ks, IRAs, Roth IRAs, and similar types of accounts allow for and should include “direct beneficiaries named as your primary beneficiaries.” When applicable, assets do not need to be in the name of a trust. Beneficiary forms on retirement accounts are ironclad; assume the beneficiary is getting the money.
Working with a qualified estate planning attorney in your unique situation and paying for a revocable living trust will likely be the most appropriate estate planning outcome. Avoiding mistakes and circumventing unforeseen quarks. But for the most part, I have found alternative beneficiary designations to be entirely satisfactory, free, and I have to admit sometimes it’s just about getting something done.
Editor’s note: This blog offers informal investment and financial planning advice. If appropriate, seek the counsel of experienced, ideally objective, financial, tax, or estate planning professionals. Past performance is not indicative of future performance.