Simple Solutions to Reduce Your Estate Tax

The abundance of speculation about where the estate tax exemption will land in 2026 leaves many individuals trying to make sense of their estate planning options. Let’s cut through the noise, identify some simple solutions to reduce estate tax, and look at the impact of these strategies in action.

How to Think About Reducing Your Taxable Estate

Your attorney, financial advisor, and accountant often work together to ensure your assets will pass the way you intend at your death. This foundational estate plan—beginning with a durable financial and healthcare powers of attorney, last will and testament, and often a revocable trust—requires careful planning, thoughtful conversations, and periodic review of your documents and how your assets are structured and titled.

The next level of estate planning considers whether any estate tax might be due upon your death. While tax shouldn’t be the primary driver of your estate planning decisions, it is certainly worth considering if some of your estate is subject to estate tax.

It’s important to note that estate tax only applies in certain situations. Due to the unlimited marital deduction, it generally doesn’t apply to any assets left directly to your surviving spouse. And due to the current estate tax exemption for single filers, estate tax is only applied to assets over $13.61 million for inheritance left to individuals other than your spouse. With portability, married couples can leave a combined total of $27.22 million ($13.61M x 2) to beneficiaries. Read more about portability in George Climer’s Estate Planning Update: Portability Filing Relief.

In the absence of new legislation, this exclusion amount of $13.61 million per decedent is scheduled to “sunset” back to its 2017 level of $5 million, adjusted for inflation, on December 31, 2025. The federal estate tax rate begins at 18% for the first dollar over this exclusion amount and reaches 40% once you are $1 million over the exclusion amount. For simplicity, we’ve assumed a 40% estate tax rate in the examples below.

With today’s exclusion amount of $13.61 million per person: A married couple with a taxable estate of $35 million would have an estate tax of approximately $3 million payable at the second death.
($35M – 27.22M) * 0.40 = $3.1M

If the exclusion sunsets to $7 million per person: The same couple with a $35 million taxable estate would have an estate tax of approximately $8.4 million payable at the second death.
($35M – $14M) * 0.40 = $8.4M

NOTE: If the current tax law sunsets, the top estate tax rate will increase from 40% to 45%. For example purposes, we use the same 40% tax rate.

Those whose taxable estates exceed the projected 2026 post-sunset exclusion amount—$7 million for individuals/$14 million for married couples—are concerned about losing the additional exemption available today. Many of our clients in this situation have considered ways to “use” some of this exclusion before it is lost. The only way to take advantage of the exclusion amount that might go away ($13.61M – $7M = $6.61M) is to give away more than $7 million before December 31, 2025, assuming the tax law sunset occurs.  However, legislation may pass before that deadline with an estate exclusion amount unrelated to either the current or sunset values.

Planning to use your exclusion is a big decision and requires careful analysis and consideration before committing to an irrevocable gift of this size. While some individuals have employed strategies such as those described by Phillips Bragg and Jen Muckley in Estate Planning: Keep Your Eye on the Sunset, others have opted for a “wait and see” approach. If you plan to make a gift of this nature before December 31, 2025, we suggest consulting with your attorney, as their plates will likely be full as the deadline approaches. Beginning the conversation as soon as possible allows your attorney more time to prepare for various scenarios.

For clients who aren’t quite ready to use their exclusion amount with large irrevocable lifetime gifts, there are “estate freeze” techniques. As the name suggests, these strategies are intended to maintain your taxable estate at its current level while keeping the growth of your assets outside of your taxable estate. Many of these strategies are more favorable in a low-interest-rate environment, such as Grantor Retained Annuity Trusts (GRATs), intra-family loans, installment sales to dynasty trusts, and Charitable Lead Annuity Trusts (CLATs). Despite the higher interest rates we are experiencing in 2024, one shouldn’t rule out these strategies without some analysis. Estate freeze techniques that are more favorable in a high-interest rate environment include Qualified Personal Residence Trusts (QPRTs) and Charitable Remainder Trusts (CRTs). Learn more about each of these strategies in the following articles:

• Pay It Forward: A Primer on Intra-family Loans
• Reduce Your Estate: Wealth Transfer Planning
• Hand-Me-Downs and Split-Interest Gifts

Simple Solutions to Estate Tax Reduction

When clients have explored all the options outlined above and decide these aren’t ideal for their current goals, they often ask about simpler ways to reduce their taxable estate. In these cases, we turn to what we call the “low-hanging fruit.” These solutions don’t require an attorney to draft a document or a CPA to file an extra income tax return each year. They are flexible; they don’t require a lifetime commitment and you can adjust them as your life and financial plan evolve. If the market is down for a few years and you aren’t sure you’ll have enough to support your expenses for your lifetime, these are easy to turn off. They sound simple, but their impact can be outstanding.

• Annual Exclusion Gifts: Each year, an individual can give up to the annual limit—$18,000 in 2024—to as many individuals as they like. This “annual exclusion amount” typically increases a little each year to account for inflation. Gifts up to this amount do not count against your estate exclusion amount—$13.61 million in 2024.
• Qualified Education and Medical Expenses: In addition to the annual exclusion amount, you can also pay for another individual’s qualified education and medical expenses if paid directly to the institution.
• Charitable Gifts in Life: Gifts to charity may provide income tax advantages if you are itemizing your deductions or are over age 70.5 and gifting directly from your IRA (a Qualified Charitable Distribution, or QCD); charitable gifts also directly reduce the size of your taxable estate.
• Charitable Gifts at Death: Your estate will receive a charitable deduction for any bequests to charity at death. Some clients have built this into their estate plan so that anything above the exclusion amount goes to charity, ensuring they will not pay estate tax. Keep in mind, if the exclusion amount is reduced, the amounts going to other non-charitable beneficiaries of your estate plan are reduced. Your document provisions can be written in various ways to align with your intentions for amounts to individuals and charities.

The Impact of These Simpler Strategies

Since these “low-hanging fruit” options sound simple, we find it’s easy to underestimate their value over time. A few examples help illustrate how these strategies can reduce your taxable estate.

In these sample scenarios, we get to know Cindy and Joe Smith. They are currently 65 years old and have two adult children and five grandchildren.

Annual exclusion gifts

Cindy and Joe Smith decide they will each make the following gifts every year for the next 18 years:

• $18,000 to each of their two children as well as to each child’s spouse;
• $18,000 to 529 plans for each of their five grandchildren.

Together, Cindy and Joe make a total of 18 gifts of $18,000 each year for 18 years.

Direct payment of tuition

In addition to making the annual gifts above, the Smiths decide to pay for their grandchildren’s college expenses, making payments directly to the schools. For simplicity, we’ll assume the five grandchildren all attend college at the same time starting this year. The average annual cost for each grandchild is $30,000 and they each attend for four years.

Direct payment of health expenses or health insurance premiums

Cindy Smith also has a niece who is self-employed, and her medical insurance premiums are high. Cindy pays her niece’s $15,000 annual premiums directly to the insurance company and $5,000 average annual out-of-pocket expenses directly to the provider. She does this for 20 years.

Charitable Gifts

Joe Smith has a heart for adults with special needs. He gifts $45,000 per year to a nonprofit that provides education, social interaction, and life skills for these adults. He does this for 22 years, until he passes at age 87.

Spending and Consuming More

The Smiths decide to rent a beach house large enough for their extended family to enjoy together for two weeks every summer. They spend $30,000 each year for the rental, food, and other associated expenses. They do this from ages 65 until their passing at 87.

The Combined Impact of These Simpler Strategies

As you can see, using these strategies—individually or combined—can have a tremendous impact. By making the gifts and payments described in the examples above, $18.6 million is removed from the taxable estate, which could ultimately save an estimated $7.4 million in estate tax.

* In these examples, we have not assumed the gifts would grow with inflation. If gifts are increased each year, the impact is even greater.
** Future value calculations assume gifted values remained in investment accounts.
*** The estate tax applies to taxable estate assets over the exclusion amount.

Each gifting plan is flexible; you can stop or restart as needed. A word of advice: if you plan to toggle these gifts or direct payments on or off, communicate this to the beneficiaries of these payments before you begin. If your adult child understands that annual gifts of $36,000 to him and his spouse could stop at any point, they can adjust their expectations. Rather than choosing a career where they need the $36,000 yearly gift for basic living expenses, they might instead use the funds for more flexible expenditures such as travel, home renovations, replacing old vehicles, or save the funds for retirement.

For more details about how to gift to minors, see Phillips Bragg’s article Maximizing Wealth Transfers to Minors

This article is not an exhaustive list of every estate reduction strategy. Carefully consider any strategy with your attorney and CPA before implementing it. In some of the above gifting scenarios, your CPA may suggest filing a gift tax return to elect and account for joint gifts. If you would like to discuss these options and how they apply to your specific situation, please don’t hesitate to give us a call.

This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.