When you start your estate planning journey, one of the first issues you'll likely come across is the estate tax. It's a common question at our initial meetings where clients want to know if they should be concerned about the estate tax or a tax on their inheritance. Before you spend too much time worrying about the estate tax, the first place you'll need to start is to look at the amounts that the government has laid out for the tax to be assessed. For many people, their estate will fall far short of the estate tax threshold. Even if you have significant assets, you can also use your estate plan to create a plan to stay well under any tax thresholds.
When it comes to this discussion, we'll usually focus on two separate tax issues as we look at their estate planning, the gift tax exemption and the federal estate tax. Beyond the federal estate tax, you'll also need to consider whether there is a tax in your state as well. In the states where I practice, there is an estate tax (a tax on the value of the person who died's estate) in Minnesota, Connecticut, and New York, and an inheritance tax (a tax on what you receive when you get an inheritance) in New Jersey. Those tax thresholds are lower than the federal threshold (the one imposed by the federal government), so they are often more of a concern for my clients than the federal threshold.
But no matter what threshold you are looking at, it's important that you understand the limits for the 2023 tax year.
The 2023 Gift Tax Exemption
The Internal Revenue Service (IRS) announces the gift tax exclusion amount and the lifetime gift and estate tax exclusion amount for the upcoming calendar year at the end of each calendar year. For the year 2023, the IRS announced that the amount that you can give away per recipient without using any of your lifetime gift and estate tax exemption is being increased from $16,000 to $17,000. This means that you only have to file a federal gift tax return (also known as Form 709) if you give a gift to someone exceeding $17,000 in value.
This also means that married couples generally can give $34,000 per year per recipient in 2023 without any kind of gift or estate tax consequence. For example, if a married couple has two children and four grandchildren, they could donate $34,000 to each of the six descendants, or a total of $204,000 without either of the two donors being required to file a gift tax return. These donated assets will not be subject to the potential 40 percent federal estate tax when the donors subsequently pass away.
The 2023 Federal Estate Tax
Now, if someone makes gifts in excess of this $17,000 dollar annual gift tax exclusion amount in 2023, they will use a portion of their lifetime gift and estate tax exemption. This can help many people arrange their estate to avoid federal estate tax. However, most people don't have an estate that will require federal estate tax to be due when they pass away. In fact, it can get awkward when someone talks to me and says we want you to help us avoid this death tax or this estate tax. We've worked hard to accumulate an estate that is worth about $1 million dollars and let's do whatever we need to do to avoid this tax.
Well, the sometimes awkward part is when I have to say that as long as when you pass away you have less than $12.92 million dollars or if you're married, $25.84 million dollars, that federal estate tax is something you just don't have to worry about. But we will look at your state's estate tax if you're in a state that has one. Now, it's an excellent awkward situation because the result is that I just help someone understand that they will be able to pass along their estate to their survivors intact.
And while most people say the $12.92 million dollar estate tax exclusion amount doesn't apply to me, it's worth noting that this amount will continue to creep up in 2024 and 2025 based on inflation adjustments. Then in 2026, the estate tax exclusion amount is scheduled to be cut in half for the estates of people who pass away on or after January 1, 2026.
These yearly changes to the thresholds are why it's important to be reviewing your financial planning with your financial advisor each year and with your estate planning attorney whenever you see there's a change that may affect your estate.
Do You Need an Estate Plan?
If you don't already have an estate plan, or if you have one that needs to be updated, let's schedule a Legal Strategy Session online or by calling my Edina, Minnesota office at (612) 294-6982 or my New York City office at (646) 847-3560. My office will be happy to find a convenient time for us to have a phone call to review the best options and next steps for you to work with an estate planning attorney to get your estate plan prepared.