The Estate Tax Drill-Down

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Being proactive about estate planning can uncover a wealth of opportunities for tax efficiency.

Estate planning has become particularly important in recent years as state and federal estate tax laws have changed significantly; it has also become more complicated as more and more wealthy families come to own multiple properties, acquire tangible appreciated assets and use multiple trusts to fulfill different objectives.

“In the past, things were pretty simple. For example, if you had an irrevocable trust, you couldn't change it. But now there are new laws that allow changes," says Jere Doyle, an estate planning strategist at BNY Mellon Wealth Management. “And it used to be that most state taxes were synched with the federal estate tax, but now numerous states have their own estate taxes with varying exemptions. So families with homes in different states require multistate estate planning."

The End of Plan and Hold

People who are accustomed to drafting an estate plan, tucking it into a drawer and updating it only occasionally are having to change their mindset. Wealth transfer planning needs to be viewed as an active, opportunistic pursuit much like investing. It requires careful personalized strategies and frequent updates as market conditions, laws and family structures change.

The latest inflection point in estate planning was the passage of the sweeping Tax Cuts and Jobs Act, which went into effect in 2018 and opened the door to significant tax-savings opportunities for wealthy families.

The law doubled the personal estate tax exemption—which has been adjusted for inflation to $11.58 million this year—but also set an expiration date: At year-end 2025, the exemption is set to return to its 2017 level of $5.49 million per individual.

In many cases, this has prompted wealthy families to accelerate strategies they might otherwise not have put in place for years. Many are transferring assets into trusts or making gifts to beneficiaries to take advantage of the higher exemption, says Joan Crain, senior director and global family wealth strategist at BNY Mellon Wealth Management.

The new law has also given rise to some creative strategies, Crain says. Consider one long-dormant technique known as “upstream planning": This involves gifting an appreciated asset to a parent, who then bequeaths it back. The purpose of this back-and-forth is to take advantage of a tax rule that allows for a step-up in cost basis of inherited assets, thereby potentially erasing your gain from a tax perspective.

Say you have a $1 million in stock shares that you purchased for $100,000. Your $900,000 in gains would be subject to capital gain taxes when you sell the shares. But if you give the shares to your mother, you can use some of your estate tax exemption (since you can also use it while you're alive) and avoid any tax on the gift at all. When you eventually inherit the stock, the cost basis would bump up to the current market value and wipe out that $900,000 taxable gain.

There are caveats, as with all wealth transfer strategies. For example, your mother could decide to leave the shares to someone else, or other beneficiaries could contest the will and claim ownership. If your mother dies within a year of the gift, the increase in basis will be disallowed and the strategy will have to be unwound. You'd also want to be sure both you and the parent will remain under the federal and state estate tax exemptions (likely the main reason the technique wasn't used more frequently before the exemption was raised), lest the sale push either of you over the limit.

Still, given the savings that can result from such savvy estate planning, it's worth becoming familiar with some of the basic planning tools and strategies, or scheduling a meeting with an experienced estate planning advisor.

Nothing Is Certain

Families whose wealth falls under the current exemption level shouldn't assume there aren't important measures to put in place. Doyle says he categorizes families in three segments: Those with assets under the individual exemption amount; those that fall between the individual exemption and the combined exemption for couples of $23.16 million; and ultra-high-net-worth couples with wealth beyond the combined exemption.

“The planning for ultra-high-net-worth couples is actually easier than for those who are between or below the exemption," he says. This is largely because of the uncertainty of when and if the exemption will be lowered again. It is scheduled to drop in 2026, but Congress could decide to change the level before that or extend it for much longer."

These uncertainties require a nimble use of the current generous exemption as well as establishing an estate plan that accounts for multiple potential circumstances.

“If you die and haven't used your exemption, you can pass it on to your spouse," Doyle says. “But what if they subsequently lower the exemption to $3 million? That unused portion will be lost."

All of this, of course, must be considered along with state estate tax rules, which vary widely. For example, New York's state estate tax exemption is $5.4 million, while Massachusetts allows for only a $1 million break.

If estate planning seems too daunting at first, break it down into smaller building blocks, Crain says. Begin with a will, then layer on a trust. “We've had clients freeze because they don't know where to start," she says, adding that given the current federal estate tax rate of 40%, the biggest mistake is doing nothing at all.

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