Estate Taxes

If you haven’t discussed estate planning opportunities with your legal, tax, and financial professionals yet, why not use this time to schedule a meeting? Even with more generous federal estate tax exemptions, you need to be aware of local estate and inheritance taxes. Although some states have repealed their estate tax statutes and others increased their exemptions recently, a few still have the tax. A handful of states also have an inheritance tax.

Transfer Taxes

In 2024, the estate tax and generation-skipping transfer tax basic exclusion amount rose to $13.61 million, up from $12.92 million, for estates of decedents who died in 2023. Married couples filing jointly qualify for a $27.22 million exemption in 2024, up from $25.84 million in 2023.

Spousal Exemption Portability

If part or all of one spouse’s estate tax exemption is unused at that spouse’s death, the estate can elect to permit the surviving spouse to use the deceased spouse’s remaining exemption. This exemption portability provides flexibility at the first spouse’s death but has some limits. While a portability-only estate tax return can be filed up to two years from the deceased spouse’s death, it can be costly. Be aware that portability is available only from the most recently deceased spouse. It doesn’t apply to the GST tax exemption and isn’t recognized by many states.

Gift Taxes

The annual gift tax exemption increased to $18,000 per donor for each recipient in 2024, up from $17,000 in 2023. Amounts over that subtract from your estate tax basic exclusion amount.

If you do it correctly, paying for a grandchild’s or some other person’s tuition or medical bill is an exception to the gift tax. Payments made directly to providers or schools aren’t considered gifts.

Annual gifting can prove an effective estate transfer strategy. If, for example, you and your spouse each max out your annual gift exemption to two children and two grandchildren, you’ll avoid gift tax and preserve your entire estate tax exemption. In this example, a couple could gift $144,000 tax-free per year. Be sure, however, to use your annual exemption by December 31 because it doesn’t carry over from year to year.

A caution: generally, spouses who are both U.S. citizens may transfer unlimited amounts to each other without incurring any gift tax, as any assets in excess of the couple’s combined estate tax exemption will be taxed at the death of the surviving spouse, and transferring assets to the survivor defers the tax that the IRS will eventually collect.

Gifts to a non-US citizen spouse, however, are limited. Since a non-US citizen spouse may not be subject to the U.S. estate tax, one cannot transfer unlimited assets to a non-US citizen spouse since that transferred wealth could potentially avoid U.S. estate taxation upon the non-US citizen spouse’s death. Thus, when the recipient spouse is not a U.S. citizen, and regardless of whether the non-US citizen spouse is a resident or nonresident of the United States, the amount of tax-free gifts is limited to an annual exclusion amount. For calendar year 2024, the first $185,000 of gifts to a spouse who is a non-US citizen are not included in the total amount of taxable gifts.

Step Up in Basis

A new fair market value is established for assets received after a donor’s death—a step up in basis—but there is no step-up in basis for gifts received during a donor’s life. The step-up in basis sets a new starting value for inherited assets, which can make a big difference if the assets have appreciated significantly.

A caution, though: In 2023, the IRS released its Revenue Ruling 2023-2, which clarifies that transferring assets to an irrevocable trust, a popular strategy for transferring a family home, can take the trust assets out of the grantor’s estate for all purposes. If the asset is no longer part of the grantor’s taxable estate, it will not qualify for a step-up in basis. This means the assets in your irrevocable trust keep the same basis as when they are transferred to the next generation—or maybe to multiple generations. Be sure to review your trust arrangement with your estate professional.

Inherited IRA 10-Year Rule

Some non-spouse beneficiaries of IRAs must withdraw all funds from inherited accounts within ten years. The IRS is expected to issue final regulations in 2024 regarding whether annual RMDs are required or only one withdrawal of all funds in the tenth year. This rule does not apply to a surviving spouse, a disabled or chronically ill individual, an individual who isn’t more than ten years younger than the IRA owner, or a child of the IRA owner who has not reached the age of majority.

The ten-year rule also applies to trusts that receive IRA assets on behalf of beneficiaries, except for certain trusts named as an IRA beneficiary. Beware that a conduit trust must forward all IRA income to income beneficiaries, potentially exposing the inherited IRA assets to heirs’ creditors and any bankruptcy or divorce proceedings.

You should consult an attorney to determine if you’ll need to redraft the conduit trust to allow the trust to retain the assets rather than distribute income to beneficiaries. However, distributing assets this way typically results in less favorable trust tax rates. You should review your estate plan documents with an attorney if you have significant assets in retirement accounts with non-spousal beneficiaries.