6 Key Questions to Ask if Your Assets Are Over the Estate Tax Limit!
Death taxes are essentially a punishment for being successful. Working for your whole life to build a legacy, only for the government to take a portion when you pass away.
DOES EVERYONE HAVE TO PAY DEATH TAXES?
You made it! Now the government takes it!
There is a federal estate tax exemption threshold of $12.92 million per year, below which estates will not be taxed. Any amount that your state is valued above that limit is subject to a 40% tax. It is worth noting that the estate tax limit is set to be halved in 2026.
Most states have additional estate taxes to be aware of as well. New York’s estate tax covers everything over $6.58 million, and those assets could potentially be taxed at 16%. New York also has an unusual law that any estates exceeding the state estate tax exemption limit by more than 5% may have the entire estate taxed.
Should you choose to bequeath any assets to charity or have a surviving spouse, those assets are not subject to estate tax, but any other beneficiaries (such as children or relatives) are subject to estate taxes
MY ESTATE IS OVER THE TAX LIMIT, WHAT NOW?
If your estate exceeds the tax exemption limits, proper planning is vital.
As previously mentioned, federal and state-level laws are not the same, and differences exist across state lines too. Estate planning around federal tax exemptions may not work for your state’s tax law and vice versa.
IS IT POSSIBLE TO SIMPLY GIFT ASSETS?
It depends on whom you gift an asset to and when you gifted that asset. If it’s your spouse, there is no limit on the value of assets you can leave them. However, anyone other than your spouse may be subject to gift taxes. Another oddity in New York law is that there is no gift tax but there is a clawback rule. The clawback rule states that if you give someone a gift less than three years before you die, that asset is automatically returned to your estate and taxed accordingly – basically, it’s as if you never gave that gift at all.
At the federal level, the $12.92 million tax exemption is actually both an estate tax and a gift tax exemption combined; meaning that assets gifted during your lifetime are included in that limit. So, if you gifted $5 million in your life, that unfortunately counts towards the estate tax exemption limit, and those who inherit your estate can only expect a tax exemption on the remaining $7.92 million.
There are annual allowances for smaller gifts without them affecting your estate tax exemption. The maximum gift allowance is $17,000 per person per year; anything over that requires reporting and therefore affects your estate and gift tax exemption limit. For married couples, they are jointly allowed to gift $34,000 per recipient per year. Following this logic, a married couple with three children can gift their children a total of $102,000 per year without exceeding the estate and gift tax exemption or having to file a gift tax return.
HOW DOES BEING MARRIED CHANGE ESTATE PLANNING?
As with many aspects of estate planning, being married could improve your options. There is something known as “Portability” under federal law that allows one spouse’s unused exemption to transfer to their spouse. As such, a married couple could theoretically have $25.84 million of their estate untaxed (until that is halved in 2026). As with the rest of its estate tax laws, New York is not as lenient and does not have any portability laws. To work around the New York estate tax laws, there is the option of gifting your assets to your spouse and doubling them tax-free that way. Some estate tax planning tactics are only advantageous if you have both spouses involved and willing.
WHAT ARE THE DIFFERENT ESTATE PLANNING TACTICS?
There are three main tactics that estate planners use to reduce or avoid estate taxes: “Freeze,” “Squeeze” and “Burn.” Hiring an estate planner adept at handling high-net-worth cases is vital, as the required legal maneuvering is complex and even small mistakes can be costly; so much so that many estate planners choose not to take the client or only engage with a few of the different available tactics. In addition, an estate planning attorney who does not frequently work with high-net-worth individuals may not know the latest advancements or even may not comprehend the hazards associated with more intricate arrangements. It is essential to note that numerous articles have been composed on many of the methods discussed here, so this is not the appropriate place for a detailed examination.
To ensure that an estate doesn’t exceed federal or state estate tax exemption limits, estate planners may use the “Freeze” tactic. This is especially useful for people whose estates are growing faster than the rate of inflation, as the estate tax exemption is linked to inflation. Say your estate is currently valued at $12 million, just shy of the $12.92 limit now, but if your estate is growing faster than inflation is, your estate may soon exceed the limit and therefore be subject to estate taxes.
Using the “Freeze” tactic is not designed to eliminate estate growth, but rather to direct growth away from the core estate in order to avoid the estate tax.
Estate planners use a variety of methods to “Freeze” the estate size including, but not limited, to gifts, promissory notes, Defective Grantor Trusts, Grantor Retained Annuity Trusts, Preferred Partnerships, or Opportunity Shifting.
The “Freeze” method works to prevent your estate from exceeding the limit, but what do estate planners do if your estate already exceeds the limit? This is where the “Squeeze” tactic comes in. A “Squeeze” refers to squeezing the estate to a smaller size, preferably below the estate tax limit. Estate planners commonly use methods like LLCs with certain restrictions to shrink the size of an estate or the value of an asset. As an example, a client may have an estate worth $18 million. At the moment, that exceeds the estate tax limit. An estate planner might advise them to transfer their assets into a special purpose vehicle with a 30-35% reduction in valuation; the IRS then views the value of the estate at $11.7-12.6 million although the actual value of their assets has not lessened.
A “Squeeze” must come before a “Freeze.” Once an estate’s value is frozen, it becomes too late to squeeze down the estate, and any “Squeeze” would not apply to the estate.
The third and final tactic many estate planners use is to “Burn.” No, that does not mean literally burning money or assets; it means paying for the majority of expenses from the taxable part of your estate whenever possible, and not from your tax-exempt assets. Some simple examples are a person’s cost of living expenses, taxes, or fees.
Using the “Freeze” or “Squeeze” methods makes your assets immediately untouchable; that’s why it’s important to include a back-door clause that makes your assets accessible if necessary. As your assets being frozen or squeezed makes the money harder to access, it’s important to plan your estate with enough reserves to avoid having to dip into the frozen portion.
CAN I DO ALL OF THIS IN STAGES?
Yes, you can create an estate plan that is carried out in different stages. Having your estate planner develop an overall scheme for your estate that takes your concerns under advisement helps prevent future stages from impacting estate planning.
ABOUT THE AUTHOR
Stefan Dunkelgrun is a Partner in the Trusts & Estates Law practice and has comprehensive experience in high net worth and ultra-high net worth estate planning, and is seasoned in developing asset protection solutions, drafting complex trusts, business succession planning, and tax reduction strategies. Stefan also advises clients on advanced insurance solutions such as premium finance and life settlements.
To learn more about Stefan, click here.