Private Client Services

How to Plan for the 2026 Estate Tax Exclusion Drop

Posted on August 8, 2023 by

Ben Finzel

Ben Finzel

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Estate Tax Exclusion Drop“Nothing in this world can be said to be certain, except death and taxes.” When Benjamin Franklin penned this quote in the 18th century, he likely didn’t realize these two certainties would one day be combined to form the federal estate tax. The vast majority of Americans aren’t worried about the estate tax, and with current laws exempting anyone with a taxable estate less than $12.92 million, only a small percentage of Americans have reason to worry. However, according to current law, that $12.92 million amount – also referred to as the estate tax “exclusion” – is scheduled to be cut in half on January 1, 2026 

Estate Tax Exclusion

The exclusion is adjusted for inflation on an annual basis so depending on the rate of inflation for the next few years, the reduced exemption amount will likely be approximately $7 million per individual beginning in 2026. That means anyone with assets valued in excess of $7 million at the time of their death will be subject to estate tax. If an individual’s assets are close to this threshold, there are several things worth considering before 2026 to mitigate the potential exposure to estate tax. 

Give it Away: Gifting Tax Benefits

The estate tax exclusion amount is “unified” with the federal gift tax exclusion, which means the current $12.92 million exclusion is reduced for any taxable gifts made during life. For example, if an individual makes gifts totaling $10 million during their life, the amount of exclusion available to shield assets from estate tax at death is only $2.92 million ($12.92M less $10M gifts made during life = $2.92M remaining).  

Although the exclusion is set to decrease to approximately $7 million in 2026, there is currently no “clawback” rule in place. In other words, an individual can utilize their entire $12.92M estate and gift tax exclusion before 2026, and even when the exclusion is reduced in 2026, there will not be any penalty for having made gifts in excess of the reduced exclusion amount. This puts taxpayers in a “use it or lose it” situation with respect to a portion of the exclusion amount. As a result, making gifts up to the current limit before January 1, 2026, provides permanent tax savings that cannot be obtained in future years.  

Using the same figures from the example above, the taxpayer could gift an additional $2.92M of assets to a loved one in 2025 tax-free using their remaining current exclusion. If they waited until 2026 to transfer the same $2.92M —whether voluntarily or through death – the transfer would be subject to a 40% gift or estate tax due to the pending reduction in the exemption amount. In this example, proper planning to accelerate the gift before the exclusion drop would save over $1 million in tax.  

Contribute Assets to a Trust 

If not ready to give assets outright to children, grandchildren, or other loved ones, contributing assets to a trust for their benefit is also an option. As it relates to the lifetime estate and gift exclusion, contributing assets to a trust can be treated the same as if they were gifted to a beneficiary directly, and reduces the exclusion accordingly. However, using a trust provides some flexibility as it relates to how the assets will be managed and distributed over time.  

If an individual wanted to make a $2 million gift to their 18-year-old grandson, they may be more comfortable making this gift if they knew the money was to be held in trust, distributed over a period of time, and managed by a responsible trustee along the way, instead of being put directly in an 18-year-old’s bank account today. 

As with many areas of the tax law, there are a myriad of types of trusts a few that have special provisions that may be beneficial include: 

Charitable Trusts

For more philanthropically inclined individuals who want to preserve their charitable legacy and minimize estate tax, charitable trusts are an option. Charitable trusts allow the donor to select charities they would like to donate to, provide a charitable income tax deduction, and, if structured properly, can create an income stream for the individual and their loved ones, all while shielding the assets from estate tax. 

Spousal Lifetime Access Trusts 

An option for married individuals is a Spousal Lifetime Access Trust (SLAT). A SLAT is a trust established for the benefit of an individual’s spouse, which provides income to that spouse during their life. Any assets contributed to a SLAT are considered a current gift for estate and gift tax purposes, thereby reducing the individual’s lifetime exclusion at the time of the gift, while also reducing the size of their taxable estate. Typically, gifting an asset means giving up control of it, and while that’s true when funding a SLAT, it can be an easier pill to swallow knowing the assets can be accessed by the individual’s spouse down the road.  

However, to preserve the benefits of a SLAT, attorneys recommend that spousal beneficiaries not take distributions from the trust unless absolutely necessary to maintain their standard of living after exhausting all other resources. Pulling money out of a SLAT brings assets from the trust back into the spouse’s estate, which is contrary to the purpose the trust was created in the first place. Another downside to funding a SLAT is that once assets are transferred to the trust, they cannot be moved back in the event of the death of the spouse or divorce. While SLATs can be an effective estate planning tool, it’s important to understand all of the pros and cons of this type of trust. 

Irrevocable Life Insurance Trusts 

Another option to consider is an Irrevocable Life Insurance Trust (ILIT), which can be a no-brainer for wealthy individuals in “taxable estate territory” who possess insurance policies on their lives. If an individual is the owner of a life insurance policy when they pass away, the life insurance proceeds are considered part of their estate and subject to estate tax. By transferring the policy to an ILIT, the proceeds are generally not considered part of the individual’s taxable estate. As with other trusts, transferring to a trust results in relinquishing control, and as such, careful consideration should be given to the pros and cons of doing so before a transfer is made. 

There are many other types of trusts not discussed in this article that can be incorporated into an estate plan and help reduce estate tax liability. Speaking with an attorney or CPA about individual goals to determine the best type of trust is highly recommended. 

Plan for Growth 

Even if the value of an individual’s assets aren’t approaching $7 million today, consider the potential growth that could occur between now and 2026 and beyond. If an individual owns an asset that is expected to substantially increase in value, such as an interest in the family business, they may want to consider gifting that asset now before the value increases. All future growth with respect to an asset that is properly transferred is no longer considered part of an individual’s taxable estate and therefore avoids future estate tax. The cost of transferring such an asset only increases with time and could result in unfavorable gift and/or estate tax consequences. 

Planning With a Spouse 

The good news is that the $7 million exclusion amount applies per individual so if an individual is married, no estate tax will be owed unless total combined assets exceed $14 million. Even more important to note is that if one spouse passes away, the IRS allows that spouse’s unused exclusion (called the Deceased Spousal Unused Exclusion, or DSUE) to be “ported” over to the surviving spouse.  

If a spouse passes away before 2026, the amount of exclusion available to be ported over could be as high as $12.92 million. An estate tax return must be filed for the deceased spouse in order to preserve the unused exemption of the first spouse to die. Portability could have significant tax implications, particularly if the spouse passes away before 2026 while the exclusion remains high. 

You Can’t Take it With You 

One of the most popular estate planning techniques is the simplest one – spend! If past retirement age and looking for a reason to finally spend some money, the impending exclusion drop might be all the motivation needed. While it is important to remember to “not let the tax tail wag the investment dog,” in some cases it might make more sense to spend and enjoy, rather than holding, only to owe a portion to the government in the end.  

Decisions, Decisions 

Bottom line, there’s a common theme to planning around the estate tax – giving away assets. While this may not sound too appealing at first, an individual must decide whether hanging on to assets is worth the risk of being hit with that dreaded 40% estate tax. If the assets aren’t needed to maintain a lifestyle, gifting now before the exclusion drops could be worth it.  

Continue the Conversation 

Revisiting the overall picture of an estate plan can also provide other benefits in addition to reducing estate tax liability. Estate planning is an often-overlooked area of one’s financial landscape. Personal and family situations change often, resulting in a once airtight estate plan being out of date. Consulting with a CPA, attorney, and financial team can provide a more tax-efficient transfer of wealth to heirs, and peace of mind along the way.  Contact us today to learn more. 

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Ben Finzel

Manager, Private Client Services

Ben provides tax, accounting, estate planning and consulting services to entrepreneurs and high net worth individuals.

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