Why Estate Planning Is Crucial to Consider Now Despite Tax Uncertainty

The 2024 elections have raised questions about the future of gift and estate tax laws established by the Tax Cuts and Jobs Act of 2017 (TCJA). This article will examine why it’s still important to act now, even with political and legislative uncertainty.

Background

In 2017, Congress passed the TCJA, which significantly increased the lifetime gift and estate tax exemption from approximately $5.49 million to $11.18 million. This amount has since increased to $13.99 million per individual due to annual inflation adjustments. This change has allowed wealthy individuals to preserve more wealth for future generations.

Why Act Now?

Due to congressional budgetary rules, the TCJA includes a “sunset provision” with an expiration date of December 31, 2025. On January 1, 2026, the available gift and estate tax exemption will revert to pre-2018 levels, approximately half of the current exemption amount after adjusting for inflation.

Given this “sunset,” tax and legal professionals have been advising high-net-worth clients to use a portion of their exemption before any decrease in the gift and estate tax exemption.

Looking Forward in the Last Year of the TCJA

In November 2024, the presidential and congressional elections resulted in a Republican sweep of the presidency, Senate, and House of Representatives. Many believe that the current gift and estate exemption levels may be extended, as promised by President Donald Trump during his campaign. While this might seem to reduce the urgency for planning, it may not necessarily be true.

“Razor Thin” Majority

Despite the Republican sweep, the thin Republican majority (53 to 47 in the Senate and 218 to 215 in the House with two vacancies) means Congress will likely only be able to pass tax legislation via the budget reconciliation process. This process is complex and requires a majority vote, not the usual 60% majority needed in the Senate to avoid a filibuster. Therefore, virtually all Republicans and potentially some Democrats need to agree on any tax extension legislation, making an extension of current law far from certain. As a result, high-net-worth individuals should consider using the increased exemption by the end of the year.

Utilizing Freeze Techniques

One of the cornerstones of planning with the gift and estate exemption is the concept of leveraging a freeze technique. A freeze technique is any wealth transfer technique where the value of the assets for gift and estate tax purposes is considered to be “frozen” at the fair market value (FMV) as of the date of the transfer, and any growth subsequent to the transfer technique may be passed to heirs free of gift and estate tax. The benefit of using the technique is that any asset appreciation experienced after the gift transfer is shielded from gift and estate tax.

Consider the following example below. Assume a single individual has a total estate valued at $50 million in 2025. He decides that due to the likelihood of the TCJA extension, there is no reason to use exemption and chooses to do no planning for 10 years. If it is assumed the estate appreciates by 5% annually, and the exemption levels continue to increase with inflation (assumed to be 2.5% for illustrative purposes), he could be faced with an estate tax of approximately $25.4 million.

Alternatively, if he decides to proceed with planning, assuming a sunset of the current exemption levels, and uses an estate freeze technique to benefit his children and grandchildren, he can limit estate tax exposure to asset appreciation in his estate. If he gifts the exemption amount in 2025, and the gift appreciates at a 5% rate of return, those assets will grow to approximately $22 million after 10 years. As a result, the taxable estate is reduced to $58.6 million, providing an estate tax savings of $9.1 million. These are real savings that occur regardless of whether the sunset of the current exemption level happens.

Grantor Trust Status

Over time, one of the most high-impact characteristics of trust planning and gifting assets to a trust has been the ability for the trust income to be taxable to the grantor (the individual who creates the trust). A common structure incorporating this tax status is known as an intentionally defective grantor trust, which provides that while the grantor is the owner of the assets for income tax purposes, they are not for estate tax purposes. While on its face, paying income taxes on behalf of a trust created for someone else (children, grandchildren, etc.) seems counterintuitive, it is effective planning for high-net-worth individuals facing a taxable estate in that it allows all asset appreciation, which is shielded from gift and estate tax as noted above, to grow inside of the trust without an income tax drag. The compounding effects of choosing to be treated as the income tax owner of an irrevocable trust can be significant over time. The benefit exists regardless of whether the exemption is extended in 2026.

Consider the following example. B creates a trust for his descendants and funds the trust with $10 million of closely held business interest, using $10 million of his exemption. The business is assumed to continue to grow at 5% and generates $500,000 of taxable income, which is distributed to shareholders annually. It is further assumed all distributions are reinvested in a basket of marketable securities that appreciate at 5% annually. Since B is the owner of the trust for income tax purposes, he pays all of the income tax generated by the company and the marketable securities. This illustration shows the impact over a 20-year period.

Consider an alternative with the same set of facts, except that B chooses to create the trust as a non-grantor trust (meaning that the trust pays its own income tax). For income tax purposes, it is assumed the business income is taxed at an average rate of 35%, and the growth on the marketable securities is subject to an average tax rate of 15%. Over 20 years, the non-grantor trust is projected to grow to $36.47 million, compared to the grantor trust projection of $43.06 million, resulting in a tax “drag” of $6.59 million. An additional $6.59 million in the estate tax base would result in approximately $2.64 million in estate taxes at a 40% estate tax rate.

Non-Tax Reasons

Every good estate plan should have benefits that are outside of the realm of tax benefits. The non-tax benefits should be considered in developing a wealth transfer plan regardless of the state of future unknowns in the tax legislation because of the value they add. Some of these benefits may include:

1. Asset (divorce and creditor) protection: If by utilizing planning techniques a trust is created to hold assets for the benefit of others, the assets may receive a level of protection from both the grantor’s and the beneficiaries’ creditors.

2. Asset consolidation: Asset consolidation may improve asset administration during life. This may take the form of creating an investment partnership where investors may desire to hold all of their investments under one umbrella.

3. Providing liquidity to the estate in the context of life insurance trust: If a closely held business owner is faced with an estate tax, but the entirety of the estate is made up of the closely held business, the owner may be faced with a liquidity shortfall. Trust planning coupled with life insurance planning could be a great way to help ensure liquidity is made available upon the business owner’s death and held in a vehicle that receives protections noted above.

Conclusion

Notwithstanding the increased likelihood of a TCJA extension and with it, an extension of a favorable estate tax landscape, high-net-worth individuals may still want to consider wealth transfer options to capture many of the benefits discussed. If you are interested in exploring customized, tailored wealth transfer options to help fit your goals, reach out to your Forvis Mazars Private Client team to learn more.