Part 1 of a 3-part series
The IRS has announced 2023’s estate and gift tax numbers. To understand them in context, we must look at 1) the Basic Exclusion Amount, 2) the Unlimited Marital deduction, 3) how the IRS will handle taxes after 2026. These ideas are interrelated and may affect your planning options.
The Basic Exclusion Amount
The basic exclusion amount is increasing from $12.06 million in 2022 to $12.92 million in 2023, the largest adjustment the exclusion has ever received. People with a small estate, a million-dollar estate, or multi-million-dollar estate all benefit from the exclusion amount, so keep reading! The exclusion can be applied to offset tax on gifts you make during your lifetime, or on transfers you make at the time of death. When you make a gift larger than the annual exemption amount (in 2022 it is $16,000 and it will be $17,000 in 2023) the excess is subject to gift tax. To eliminate the gift tax, you can tell the IRS to apply the basic exclusion amount to the gift. Doing so consumes some of your basic exclusion amount leaving less available for use at the time of your death.
Historically, the basic exclusion amount started to increase during the GW Bush administration, was expanded under the Obama administration, and was again expanded under the Trump administration. The Trump expansion was, however, saddled with a built-in rollback set to hit in 2026. The rollback will cut the $12.92 exclusion back to about $6 million unless the law is changed before 2026. I say “about $6 million” because there is a set $5 million exclusion which is increased for inflation, so the adjusted exclusion should be about $6 million in 2026.
The Unlimited Marital Deduction
A married couple can pass an unlimited value between spouses without estate tax. It is important to understand that the Unlimited Marital deduction delays paying estate tax, it does not eliminate estate tax. Values you leave to your spouse are not taxed when you die, but they are included in your spouse’s estate and are taxed at the second death if the values exceed the basic exclusion amount.
Historically, this gave rise to a planning technique wherein the first to die would not leave all assets to the surviving spouse. This was done by creating a Bypass Trust in the Will of the first to die and leaving a value equal to the exclusion amount to that trust upon the first spouse’s death. The transfer to the trust was taxable, but the tax was zeroed by the decedent’s exclusion amount.
All value higher than the exclusion amount passed to the surviving spouse tax-free under the Unlimited Marital deduction. Then, when the second spouse eventually died the exclusion amount of the second spouse was also applied. Only the value in excess of both exclusion amounts was subject to estate tax. Both exclusions were thus used to eliminate estate tax. By contrast, if a Bypass Trust was not used then the exclusion amount of the first to die was wasted (because the value passed directly to the surviving spouse) so when the second spouse eventually died, only that second spouse’s exclusion amount was available to reduce the estate tax. Any taxable estate that used only the Unlimited Martial Deduction was wasting the first spouse’s exemption amount.
Portability Replaces Bypass Trusts
Since 2010, however, a Bypass Trust is not necessary to take advantage of both exclusion amounts. The law was changed to allow “portability” of the first exclusion. When one spouse dies, the survivor can ask the IRS to put that first exclusion on hold, then to apply both exclusions when the second spouse dies. Even without a trust, the only portion left taxable is any value that exceeds both exclusion amounts.
How has the value of your estate changed since 2010? When did you last update your legal estate planning documents? If your estate is no larger than about $6 million yet your Wills contain Bypass Trusts, then you should speak with your estate planning attorney about eliminating the burdens imposed by that now unnecessary and restrictive trust. Are you my estate planning client? Does your Will contain what we called a “federal credit trust” or a “shelter trust”? Make your appointment for a planning review asap because we can likely eliminate the burdens and costs of that restrictive trust, which was needed when the exclusion was smaller but is no longer needed now that the exclusion is larger. (Visit www.Premack.com and use the yellow button to book an appointment.)
Next Week: The 2026 Trump Rollback
Paul Premack is a Certified Elder Law Attorney for Wills and Trusts, Probate, and Elder Law issues. He is licensed to practice law in Texas and Washington. To contact us, click here.
Column published on November 14, 2022