Higher Estate Tax Exemption Means You Could Save Income Taxes by Updating Your Estate Plan

Updating your estate plan can save taxes.
Updating your estate plan could save taxes.

The estate tax exemption doubled as a result of the Federal Tax Cut and Jobs Act, raising it to historic highs. The estate tax exemption had been scheduled to increase to $5.6 million per person in 2018, but it was modified by the recent legislation to reach the current level of $11.2 million per person, or $22.4 million per couple. The inflation-adjusted exemption for 2019 is $11.4 million per person, or $22.8 million per couple.

In the article “Updating estate plan could save heirs in taxes,” the Atlanta Business Chronicle asks why this matters to an individual or couple whose net worth is nowhere near these levels.

When the most that could be transferred to a non-spouse beneficiary was under a million dollars, everyone worried about the estate tax and used trusts to minimize its effect. Since the estate tax was so much higher than the capital gains tax, it was never considered a big deal if a beneficiary paid the capital gains tax on selling trust assets, because it was less costly than paying the estate tax.

In the past, a married couple’s estate plan would often call for the deceased spouse’s assets to be placed in a trust for the surviving spouse (often called a “bypass trust”). The goal was for the trust to provide for the surviving spouse until the surviving spouse’s death, at which point the trust assets bypassed the estate of the surviving spouse and went directly to the beneficiaries, usually the spouses’ children. If the beneficiaries sold trust assets after the surviving spouse’s death, they would pay the income tax based on the value of the assets at the first spouse’s death, as oppposed to the value of the assets at the surviving spouse’s death. The higher the assets appreciated between the time of the first spouse’s death and the second spouse’s death, the higher the income tax.

For example, if a spouse owned $10,000 worth of stock which passed to a bypass trust at his or her death, and the stock increased to $100,000 at the death of the surviving spouse, the heirs would pay capital gains taxes on the amount of the appreciation ($90,000) upon the sale of the stock. If, however, instead of being in a bypass trust, the stock were included the surviving spouse’s estate, when the beneficiaries sold the stock, they would not have to pay capital gains taxes on the $90,000 of appreciation that occurred between the first spouse’s death and the surviving spouse’s death. That could be a substantial tax savings.

For those who included bypass trusts in their estate plans just to save on estate taxes, updating their estate plan to eliminate the bypass trust could bring greater simplicity as well as tax savings for the heirs.

It should be noted that the law creating the present $11.4 million estate tax exemption ends at the end of 2025, when the estate tax exemption will return to $5 million (adjusted for inflation). Because the tax laws are constantly changing, it is always a good idea to revisit your estate plan at least every three years. Learn more about what married couples should consider when updating their estate plan at https://www.galliganmanning.com/life-stages/planning-for-married-couples/

Reference: Atlanta Business Chronicle (May 31, 2019) “Updating estate plan could save heirs in taxes”

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