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Will the Federal Government’s Deficits Affect Your Estate Planning?

Possibly. But the answer isn’t straightforward and changes to tax law aren’t currently imminent. Although this post isn’t intended to speculate about COVID-19’s effect on Estate Tax directly, the federal government’s resulting structural deficits have grown in 2020 like they haven’t in decades.

The Estate Tax topic deserves a little background: Occasionally during client meetings we’ll be asked “Isn’t there an Estate Tax and is this something I have to worry about?” The question often has to do with a client’s recollection about a family member who died a few decades ago and there was a large tax imposed upon the person’s death.

(Note: we’re addressing the “Estate Tax” here. “Estate income tax” is a separate type of tax. Estate income tax accounting is relevant in nearly every trust settlement or probate administration. Estate Tax is uncommon but, when applicable, quite significant.)

For starters, the Estate Tax (sometimes referred to as the “Death Tax”) is, generally speaking, a tax on a deceased person’s total wealth. Wealth is referred to as the “Gross Estate”. An individual’s Gross Estate includes the value of assets held outright or in revocable trusts, and may account for certain lifetime gifts and/or the value of assets held in trusts over which the deceased person had control. The size of the gifts and nature of the trusts will determine whether these are included in the donor’s Gross Estate. Those values, if any, will depend on the individual’s specific circumstances and previous estate planning. This can become fairly nuanced, but nevertheless, the Estate Tax is wealth-based as opposed to income-based.

The historic exemption amount was as low as $600K, as recently as 1997. Adjusted for inflation, that’s approximately $975K as of the date of this post. While that certainly is a lot of money, by the time many clients start adding up the wealth they have accumulated in tax-deferred accounts, brokerage accounts, a home, vehicles, etc. the historic exemption seems less than lavish. Those lower exemption amounts made planning for Estate taxes especially relevant when every dollar of the Gross Estate in excess of the exemption was hit with a 55% tax.

A lot has changed since 1997. The current exemption amount is historically high, even in inflation-adjusted terms—high enough that most clients don’t need their estates administered in a manner that mitigates Estate Tax. So, while our clients’ estate planning documents may plan for the possibility that the Estate Tax becomes more common once again, those terms are typically included as a precaution. But precautions are included for uncertain times like these.

Even though the exemption amount hasn’t decreased for a very long time, the federal government is regularly reminded of its ability to revise this amount downward. (For example, while presidential political platforms seldom prioritize Estate Tax as a high-priority policy, each of the last few elections have included a candidate supporting a decreased exemption amount or other increased burdens on wealth transfer.)

Since we can anticipate a widening deficit of the federal government, we can similarly speculate about a decrease in the exemption amount and/or increase in the tax rate at some point in the future. While this post is not intended to analyze recent events in any detail, the federal government’s response to current events has increased its deficit considerably. It is foreseeable that this will continue. In other words, even though the Estate Tax hasn’t been a major consideration for many individuals' estate planning in several decades, we believe that clients would be wise to review their estate plans accordingly—in the event that the Estate Tax becomes more commonly-applicable. How the exemption amount and effective tax rates may be revised is largely speculative at this time.

So what is the current Estate Tax exemption amount and will you be subject to it? There are a few ways to answer that question. The simple answer is to refer to the IRS’ website since the exemption amount is subject to change annually and current increases are temporary until January 1, 2026. (This post will not be updated as the laws change.) The exemption amount per individual is currently $11.7M. The amount on January 1, 2026 will drop to approximately $6M under current law. Foreseeable proposals may lower the amount closer to $3.5M, potentially beginning immediately upon adoption of legislation. There are several variables to this equation (inflation indexing, current law, legislative proposals, etc.) so it’s impossible to forecast the exemption amount with certainty. For the purposes of estate planning, if in doubt, we would strongly recommend that you discuss the possibility of Estate Taxes with a professional who is knowledgeable about the topic.

Could a change in the Estate Tax exclusion affect you? If your estate planning currently contemplates Estate Tax, considering how much wealth potentially subject to the tax if laws change, it makes sense to discuss the matter with your financial advisor, accountant, and/or estate planning attorney during your next meeting. And even if it doesn’t apply, confirmation that it shouldn’t apply can often be determined without much difficulty.

Let us know if we can help.


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