The federal estate tax, sometimes referred to as the “death tax,” has been a point of contention in every presidential campaign in recent memory. Members of the media love to expound on the push and pull between politicians on this issue. Some see the estate tax as a necessity while others see it as an unfair burden to be avoided at all costs. The level of controversy around federal estate taxes might lead you to wonder if your estate will be impacted and by how much? What can investors do about estate taxes?
The first estate tax was instituted in 1797 to fund a Navy to defend our national interests in an undeclared war with France;1 the tax was repealed in 1802 at war’s end. This happened again in 1862 and 1898 to fund the Civil War and the Spanish-American war.
The modern federal estate tax was created in 1916 at the end of World War I as a levy on large estates to address concentrations of wealth from corporate ownership. At that time, the government levied a 10% tax on estates over $50,000 (equivalent to $1.2 million today). Individuals who died with less than $50,000 in 1916 paid no estate tax.
Today, estates pay a 40% tax on assets over $11.7 million ($23.4 million for married couples). Approximately 0.1% of estates in 2020 owed estates taxes; the other 99.9% were individuals who died with less than $11.7 million and owed no federal estate taxes. For the past fifteen years, fewer than 1% of estates have owed federal estate taxes, meaning most Americans can breathe a sigh of relief, but for those who aren’t exempt, the 40% estate tax bill is a big deal.
Lifetime Exclusion Limits
The lifetime exclusion limit is the amount of an estate that is free from federal estate taxes (currently $11.7 million). This lifetime exclusion has changed dramatically through the years. In 2016, the exclusion amount was just over $5 million (half of what it is today); in 2006, it was $2 million. The 2001 exclusion was a mere $675,000.
Changes to estate taxes will keep on coming. Politicians have suggested that estates considerably less than $11.7 million could be fair game for future estate tax legislation changes. The 2021 lifetime exclusion amount, which is adjusted for inflation, is expected to continue growing for the next few years, but, in January 2026, the current exclusion will expire, resetting to $6 million unless Congress takes action. Congress could either delay the reset or change the exclusion to a different amount altogether, which could be significantly higher or lower than $11.7 million.
What This Means for You
It’s nearly impossible to predict what will happen with the lifetime exclusion amount when the current exemption expires in 2026, but investors can take steps to be prepared no matter what the future holds:
Practical Steps to Address Federal Estate Tax Uncertainty
- Calculate the taxable value of your estate. Know where you stand. Add up all of your assets – financial and investment accounts; retirement accounts; real estate; cars; collectibles; annuities; and assets held in revocable trusts. (Generally, irrevocable trusts are not counted as part of your taxable estate.) Are your assets valued below $11.7 million? Are they valued below $6 million? What if the exemption is lowered even further?
- Consult with an experienced estate planning attorney. Review your estate plan regularly. Ensure that your estate plan is flexible and positioned to minimize future estate taxes – both federal and state. Some states levy state estate taxes on top of federal estate taxes. State estate tax exemptions right now are significantly lower than the current federal exclusion amount, adding to potential tax burdens.
Individuals whose estates are close to or over exclusion amounts can take practical steps in their lifetimes to limit estate tax liability:
Methods to Limit Your Estate Tax Liability
- Give charitable gifts while you are alive. Giving to qualified non-profits during your lifetime helps the world around you, increases personal feelings of purpose and wellbeing, reduces your taxable estate, and preserves your lifetime exemption amount.
- Give annual gifts to individuals up to the maximum annual limit ($15,000 in 2021). Individuals can give a $15,000 gift to anyone they want each year. If you are married, your spouse can also give $15,000 to anyone they would like as well, even to the same person to whom you gave a gift. If you have children or extended family you plan to pass money on to in your will, consider giving some of that money now. These annual gifts won’t reduce your lifetime exemption amount but will reduce your taxable estate. By making these gifts you also get the future growth of the gifts out of your taxable estate.
- Establish a Charitable Remainder Trust for highly appreciated assets. This type of irrevocable trust can provide you with a certain level of income for your lifetime with the remainder going to the charitable organizations of your choice at your death. A Charitable Remainer Trust gets the assets out of your taxable estate and provides an income tax deduction in the year(s) you fund the trust.
- Talk with an estate planner. Ask if creating a trust could minimize potential estate taxes for your specific situation.
No matter who or how many people are impacted by federal estate taxes today, the federal estate tax has the potential to change with each election cycle and impact Americans significantly more or less in future years. Investors would be wise to learn as much as possible and to keep tabs on estate values and current legislation as time goes on.
- Most Americans will not owe federal estate taxes in 2021, but future years are less certain.
- The current lifetime exclusion amount is $11.7 million for individuals, $23.4 million for married couples.
- The lifetime exclusion will reset to $6 million in January 2026 or require congressional action to intervene.
- Investors can take practical steps to prepare for future changes to federal estate tax laws.
For more information about Covenant Trust’s outlook on the markets, or to speak with a Covenant Trust representative about developing a strategy that’s right for you, contact us at 800-483-2177.
- Darien B. Jacobson, Brian G. Raub, and Barry W. Johnson, “The Estate Tax: Ninety Years and Counting,” https://www.irs.gov/pub/irs-soi/ninetyestate.pdf.
The information provided is general in nature, educational and is not intended as either tax or legal advice. Consult your personal tax and/or legal advisor for specific information. Covenant Trust is incorporated in the State of Illinois and is supervised by the Illinois Department of Financial and Professional Regulation. Covenant Trust accounts are not federally insured by any government agency. Clients may lose principal as a result of investment losses.