Charles R. Kennedy, CPA
Vice President & Director of Tax Services
For most taxpayers, estate planning these days is almost entirely focused on pushing estate value down far below the federal estate tax exemption of $13.9 million (or $27.9 million for married couples). These are big numbers, and most people will look at them and think they would never have to worry about estate taxes. But consider these two critical factors:
- The federal exemption is scheduled to be slashed in half as of January 1, 2026, as provisions of the Tax Cuts and Jobs Act (TCJA) of 2017 expire. This will push thousands of taxpayers’ estates into estate tax territory unless Congress acts to change the law before the end of 2025.
- For many people, the tremendous appreciation in the value of real estate and the cost of certain business assets over the past several years may have, indeed, elevated their estates to estate tax territory. If you have any question about the size of your estate, now is the time for a valuation.
The Political Landscape
It was during President Trump’s first administration that the TCJA – his signature tax bill – significantly increased the estate tax exemption, so it seems likely that the White House and the Republican-controlled Congress would act this year to either make the higher exemption permanent or extend it for several years. 
There currently does not seem to be urgency in the Trump administration to move a tax bill forward. There has been some movement in Congress, but a budget reconciliation bill requires a lengthy process and coordination between the House and Senate.
How the Estate Tax Works
The federal estate tax is a marginal tax, meaning it applies only to the portion of an estate that is above the federal exemption, but at 40% it takes a big chunk out of the taxable value.
In other words, if an unmarried person were to die this year with an estate valued at $16.5 million, to calculate the estate tax you would subtract $13.9 million (the current amount that is exempt from the estate tax) from the estate’s value of $16.5 million.
The remainder is $2.6 million. The federal estate tax would be applied only to this “marginal” amount, not the full value of the estate. Hence, the 40% estate tax in this case would total $1 million.
But consider what could happen if that same person were to die on or after January 1, 2026, when the estate tax exemption is scheduled to be reduced to about $7 million. The marginal portion of the estate subject to the estate tax then would be $9.5 million, and the estate tax would be $3.8 million – more than a 200% increase.
In addition, the person’s estate may be liable for state estate taxes, depending on where they lived. In Massachusetts, estates valued over $2 million are required to file a tax return with the commonwealth. Estates valued at over $2 million are subject to tax rates ranging from 8% to 16%, depending on the total value of the estate.
How an Estate is Valued
The calculation of an estate is fairly simple. It is based on the value of total assets minus liabilities.
It’s important to understand that the assets in an estate must be valued at current fair market value, not the price at which they were originally purchased. This may involve hiring valuation professionals to ascertain the value of assets like real property, art and antique collections, and businesses. Additionally, fair market value changes over time, making it essential to update the valuation of an estate every three to five years.
Assets will include real property, homes, bank accounts, investments and retirement plans, vehicles, art collections and other items. Liabilities such as mortgage debt, vehicle loans and other debt are backed out of the total to reach the final calculation of estate value.
With homes in Massachusetts easily valued at $1 million or more, it’s easy to see how an estate can exceed the state estate tax exemption before the owner is even aware.
That’s why estate planning is even more critical today than in the past, and must be considered an on-going process since the federal estate tax is poised to affect more taxpayers and the value of real estate and other assets continues to rise.
Estate Planning Strategies
For taxpayers concerned about avoiding estate taxes, several strategies can be utilized to lower the overall value of their estates or place assets into entity structures that will protect them. Here are a few:
- Gifting – In anticipation of the change in the federal estate tax exemption, many taxpayers have already begun gifting assets to their heirs. Gifting must be done in consultation with a trusted advisor, as there are tax consequences for all parties. Additionally, a gift must be completed in order to lower the overall value of the estate.
- Legacy Trust – The trust functions as a separate estate, which minimizes the impact of estate taxes and protects it from creditors. A legacy trust can be structured to last many years beyond the original owner’s death, during which time it will never be included in any of the heirs’ estates.
- Revocable Trust – A revocable trust bypasses the probate process when an owner dies, which significantly simplifies the transfer of the estate for the heirs. These are commonly used. One advantage is that there is no requirement to file a tax return for the trust until the owner dies. As the name suggests, a revocable trust can be altered or cancelled by the grantor during his or her lifetime. It’s important to note that a revocable trust does not remove assets from the owner’s estate, so it has no impact on the overall value of the estate.
- Irrevocable Trust – An irrevocable trust moves the assets from the grantor’s control to that of the beneficiary, consequently reducing the value of the person’s estate and protecting the assets from creditors. Irrevocable trusts cannot be amended or cancelled without permission of the trust’s beneficiaries or by court order. (Rules vary by state.) For a business owner, an irrevocable trust may lower the value of their estate for estate tax purposes.
- Charitable Lead Trust – A charitable lead trust is a type of irrevocable trust that provides for regular payments to a designated charity for a specified period of time such as 20 years, then distributes the corpus of the estate to beneficiaries. Depending on how long the trust remains active, it can enable beneficiaries to inherit larger sums than they would without it due to asset growth.
Oftentimes a “trust protector” is appointed to help oversee a trust. This is a person who is completely removed from the process and independent – possibly a lawyer or a banker – who can disband the trust if there is a legitimate reason for doing so. For example, if the government changed tax laws in such a way that the trust was severely disadvantaged, the trust protector could step in. But they could not terminate the trust simply at the request of a beneficiary.
Time is Running Out
The reduction in the federal estate tax exemption is only nine months away, and it’s unknown whether Congress will step in and make the current exemption permanent. If you are considering gifting or setting up trust, you will want to act quickly.
If you would like to explore ways to protect your estate from estate taxes, contact your G.T. Reilly advisor today.
