High-net-worth individuals often face significant estate tax challenges. Both federal and state estate taxes can heavily impact estates.
Fortunately, there are strategies, including various trusts, that can help mitigate these tax burdens. Here, we’ll explore how different irrevocable trusts can provide estate tax efficiency.
Estate Tax Exclusions
Estate tax exclusions are a crucial aspect of managing estate taxes. The federal estate tax exclusion allows a certain amount of your estate to be transferred tax-free. As of 2024, this exclusion stands at $13.61 million, with a maximum estate tax rate of 40 percent.
There is an unlimited marital deduction, allowing property transfers to a surviving spouse without incurring estate tax. However, this deduction only applies if the surviving spouse is a U.S. citizen.
State-level estate taxes can also come into play. Connecticut has this type of tax, and the exclusion matches the federal exclusion of $13.61 million.
Pending Reduction in Exclusion
The current high exclusion is a result of the Tax Cuts and Jobs Act of 2017, which doubled the previous exclusion. This provision is set to expire on January 1, 2026, reverting the exclusion to the 2017 level of $5.49 million, indexed for inflation.
This change will expose more estates to estate taxes, making proactive planning essential for people who have been protected by the record-high exclusion.
Federal Gift Tax
To prevent avoiding estate taxes through lifetime gifting, the federal government imposes a gift tax. This tax is unified with the estate tax, meaning the same exclusion applies to both. Any large gifts given during your lifetime will reduce your available estate tax exclusion.
There is, however, an annual gift tax exclusion. In 2024, you can give up to $18,000 per person, per year, tax-free. This allows for strategic gifting or irrevocable trust funding to reduce your taxable estate gradually without using up your lifetime exclusion.
Qualified Domestic Trust
For those married to non-U.S. citizens, the qualified domestic trust (QDOT) offers a solution. By placing assets into a QDOT, you can defer estate taxes on those assets until your spouse’s death.
The trustee of the QDOT, who must be a U.S. citizen or institution, manages the trust and distributes income to the surviving spouse.
These distributions are subject to ordinary income taxes but not estate taxes. Principal distributions may be subject to estate tax unless they meet hardship exemptions.
Qualified Personal Residence Trust
A qualified personal residence trust (QPRT) allows you to transfer your home to a trust while continuing to live in it for a specified term. This strategy will reduce the taxable value of your estate.
When you transfer your home to a QPRT, you effectively make a taxable gift. However, the gift’s value is reduced because the beneficiary does not gain control until the trust term ends. This reduction in value can result in significant estate tax savings.
Generation-Skipping Trust
A generation-skipping trust (GST) can be an effective tool for transferring wealth across multiple generations while minimizing estate taxes. When you create a GST, your grandchildren (or later generations) are the beneficiaries, skipping your children.
While this might seem like a way to bypass your children, they can still benefit from the trust. They can receive income distributions and use trust property. The main advantage is that the estate tax is applied once, reducing the overall tax burden over two generations.
Take Action Today!
Even if taxation is not a source of concern, legal counsel is invaluable when you are planning your estate. There are different ways to proceed, and the ideal course of action will depend on the circumstances. Personalized attention is key, and this is what you will receive when you choose our firm.
To schedule a consultation at our Westport or Glastonbury, CT estate planning offices, call us at 860-548-1000 or send us a message through our contact page.
