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What is the long-term view on estate taxes?

The estate tax is a resilient part of the U.S. tax code. Despite calls to abolish the so-called federal “death tax,” it remains. An increase in the gift tax exemption from $5.49 million to $11.2 million (double this figure for couples), however, means fewer estates will have to pay – at least those who pass away between 2018 and 2025.

We last wrote about estate taxes in December when it was still unclear which of the senate or house reforms would make it into the final package. This is an update post that incorporates a bit of history on estate taxes in our country.

More than 100 years

The Revenue Act of 1916 was the U.S. law that created a tax on wealth transfers between an estate and beneficiaries. The estate paid the tax (estate tax) rather than the beneficiaries (inheritance tax: several states have versions of this type of tax, but Colorado does not). Even at that time there was an exemption threshold of $50,000. 

The IRS published an intriguing history about 10 years ago for those who want to learn more details.

Twenty years ago, the exemption was $625,000. Because this amount excluded charitable gifts, these became a widely-utilized tool in many estate plans. An individual with an estate of $1.5 million might leave $900,000 to charity with the reminder $600,000 and a life insurance policy transferring without tax consequence.

What can we take from this history? The federal estate tax is likely to remain and the exemption amount is likely to vary. The current one is only on the books for eight years.

In between estates

For families who have estates valued somewhere in between the old and new thresholds, there could be complications.

If one spouse died under the old, lower exemption, the surviving spouse benefits from the higher exemption until 2025. If future lawmakers decide to lower the amount (the last time this happened was 1935), it could cause problems.

Is a trust still needed? Should it be updated?

For those who may have used irrevocable trusts or trusts with generation-skipping features, it is important to schedule a review your estate plan.

An irrevocable trust may have been set up to hold assets over the old exemption. These assets might now qualify for stepped-up basis and could/should be moved back into the estate. Making changes to these types of trusts is difficult requiring probate court review. For this reason, seek individualized legal guidance from an experienced estate planning attorney.

Another type of trust moves assets out of an estate to a trust that will benefit children and/or grandchildren. These trusts may be set up to use an automatic formula that adjusts with the exemption amount. For estates valued between $5.5 million and $11 million, the higher threshold could have the unintended consequence of leave a surviving spouse with nothing.

These examples illustrate what can occur if an estate plan is created and then forgotten for decades. It is a good rule of thumb to set up a review after significant life changes or every five years.

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