A perplexing issue for many clients planning their estates surround the federal estate tax exemptions. Currently everyone has an exemption of $12.06 million. That amount is reduced by any “taxable gifts” that one makes during life. Taxable gifts are transfers exceeding the annual gift tax exclusion amount, which in 2022 is $16,000. Last year it was $15,000.
A married couple, therefore, has $24.12 million of exemption. This exempts a large majority of estates from federal estate tax. Without any further legislation passed by Congress and signed by the President, the exemption is slated to decrease to an amount approximating $6.5 million on December 31, 2025.
In addition to the federal gift/estate tax exemption, there is a similar exemption for the generation skipping transfer (GST) tax. If you have a larger estate, it often makes sense to create trust shares for your children that will one day go on to the grandchildren.
Many don’t understand that you can name each child as the trustee of his or her own share, so that child can independently decide what assets to invest in, what distributions to make, and where that trust share would be distributed at his or her death. So it is very similar to owning the assets outright, but by holding in a trust share it may be protected from divorce or lawsuit creditors such as a malpractice case or business dispute issue.
When creating these separate trust shares, your estate plan can allocate your GST exemption to the share. When GST exemption is allocated, the share assets won’t be included in the child’s estate for federal estate tax purposes, meaning that it escapes estate taxation.
The difference between the estate tax exemption and the GST exemption is that the unused estate tax exemption can be transferred to a surviving spouse, where the unused GST exemption cannot be.
This is best illustrated by example. Assume Don and Diane’s estate plan leaves everything to one another, then at the death of the survivor creates a trust for their daughter Becky. Becky has two children, Dan and Jacob. At the time of Don’s death, his estate was worth $12 million, and it was all transferred to Diane. At Diane’s death, her estate (which included what she inherited from Don) grew to $18 million.
Because everything was transferred to Diane, Don did not use any of his estate tax exemption. Assume that he died in 2025 when the exemption was $12 million. That unused exemption transferred to Diane. Assume that at the time of Diane’s death the exemption had decreased to $6 million. Her $18 million combined estate is not subject to federal estate tax because her exemption plus Don’s unused estate tax exemption is $18 million, enough to cover both estates.
What about the GST exemption? That exemption isn’t transferrable. So Don’s unused GST exemption was lost. Because Diane died with only $6 million of GST exemption, there are two trusts created for Becky, a GST exempt trust for $6 million, and a nonexempt trust for $12 million.
Assume that when Becky died the GST exempt trust grew to $12 million. It escapes taxation from Becky’s estate. Assume the nonexempt trust grew to $20 million. It is taxed in Becky’s estate, plus her own assets add to the estate tax burden.
This issue can be addressed with proper planning. I hope that I gave you something to consider when speaking to your own estate planning attorney.
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