MM&C Estate Planning Attorneys advise clients on strategies to reduce the value of an estate for tax purposes. Here are seven common strategies we consider:
Optimizing Federal Exemptions, Credits, and Deductions
Estate tax liability is calculated by multiplying the value of the estate and adjusted taxable gifts by the federal tax rate, which currently ranges from 18% to a maximum of 40%. However, exemption amounts are applied first.
1. Use the Basic Exclusion Amount
Most estates have a basic exclusion amount to shield assets from estate and gift tax. The basic exclusion amount is the amount an individual or estate can give during their lifetime or at death to people other than their spouse or a charity without generating an estate or gift tax liability. The basic exclusion amount increased in 2022 from $11.7 million to $12.06 million. However, the amount is expected to decrease to about $6 million in 2026 with the sunset of certain Tax Cuts and Jobs Act provisions, or it could change sooner with the political tides. We recommend that clients who can benefit from the larger current exemption amounts take advantage of them while they are available.
2. Use the Generation-Skipping Transfer Tax Exemption
The generation-skipping transfer (GST) tax exemption is currently $12.06 million for individuals. This exemption allows you to transfer wealth to your grandchildren or younger generations without paying the GST tax. Keep in mind that the GST tax exemption is not portable: upon death, a person’s spouse may be able to use the remainder of the deceased spouse’s estate tax exemption, but not the deceased spouse’s GST tax exemption. Like the estate tax rate, the GST tax rate is 40 percent.
3. Use the Annual Exclusion
Another strategy is to utilize the annual exclusion, which has increased from $15,000 to $16,000 for 2022. This exclusion, which applies per recipient per year, can be used for gifts to an unlimited number of individuals. Gifts in excess of this amount will require you to file a federal gift tax return (Form 709) and will count against your lifetime exclusion amount (unless the tax is otherwise offset).
4. Use the Ed/Med Exclusion
When you have maxed out your exemptions and annual exclusions, there may still be other strategies available. One less widely known strategy is the ed/med exclusion. This involves the direct payment of someone’s medical or educational expenses. These gifts are not subject to federal gift or GST taxes.
Only certain payments qualify, so you should read the rules carefully. In general, these payments must be made directly to schools or medical providers. For example, only tuition payments are eligible, so money spent on room and board, supplies, and books does not qualify. The educational institution must also meet certain requirements.
5. Use the Spouse’s Exclusion Amount
In general, each spouse has an exclusion amount when gifting to third parties, and gifts can be split between the spouses each year. When spouses split gifts, the gifts made by one spouse during the year will be treated as if each spouse gave half, allowing the use of both spouses’ exclusion amounts.
Another method for using a spouse’s basic exclusion amount is using portability. The unused portion of the deceased spouse’s exclusion amount can be transferred to the surviving spouse, effectively increasing the exclusion amount available to the survivor. Portability requires a valid election within a short time after the spouse’s death.
6. Leverage the Estate or Gift Tax Charitable Deduction
Setting up an irrevocable trust for charitable giving also has tax advantages. The charitable contributions may be deductible for income, estate, or gift tax purposes, and the trust may also serve the client’s other tax or nontax objectives.
Don’t Forget About State Estate and Inheritance Taxes
7. Consider Moving to a State Without an Estate Tax
If you live in one of the seventeen states that has an estate or inheritance tax, you might assess whether it would be worth it to move to one of the other thirty-three states to avoid those taxes. The states with an estate or inheritance tax are Connecticut, Hawaii, Illinois, Iowa, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Jersey, New York, Oregon, Pennsylvania, Rhode Island, Vermont, and Washington. The District of Columbia also has an estate tax.
The Maryland estate tax applies to estates valued over $5 million. The Maryland estate tax rate starts at 0.8% and tops out at 16%. For 2022, the District of Columbia estate tax applies to estates valued over $4,254,800 (this number will likely increase annually for cost-of-living adjustments). The District of Columbia estate tax rate ranges from 11.8% to a maximum of 16%.
How MM&C Estate Planning Attorneys Can Help
At MM&C, we meet with clients for a consultation to determine your goals for creating an estate plan and your current tax bracket and tolerance for incurring income tax obligations on behalf of estate beneficiaries. We make sure that you understand the income tax implications of the estate plan and draft accordingly. We remain updated on the federal and state laws that affect the estate plan, as they change frequently, and advise our clients accordingly.
Schedule a Meeting
Let us help you choose the best course of action to update your estate plan. We are more than happy to meet with you by phone or video conference.
David Lucas is an attorney in the Estates & Trusts and Business & Tax practice groups at Miller, Miller & Canby licensed to practice in Maryland and the District of Columbia. He focuses his practice in Estate Planning and Trust and Estate Administration. He provides extensive estate and legacy planning, asset protection planning, and retirement planning.