The Tax Cuts and Jobs Act of 2017, or TCJA, brought many changes to the tax code. For families and individuals, it reduced income taxes and increased the estate tax exemption. However, a sunset provision was written into the law, making some changes effective only for tax years 2018 through 2025. So unless Congress extends them or makes them permanent, some tax rules will automatically revert after 2025.
Here’s a closer look at how an estate tax sunset in 2025 could affect you and how you can prepare.
What the Tax Cuts and Jobs Act Changed
Some of the major changes the TCJA made to the tax code include:
- Reduced personal income tax rates and doubled the standard deduction
- Capped the state and local tax deduction
- Limited the deduction on home mortgage interest
- Eliminated many itemized deductions
- Set a flat corporate tax rate of 21%
- Allowed business owners to deduct 20% of qualified business income
- Increased the estate tax exemption amount
What Is Estate Tax?
An estate tax is collected on the taxable portion of the estate a person leaves to their beneficiaries. There’s a federal estate tax, but some states also have an estate tax. The TCJA is a federal regulation, so it affects the federal estate tax. If you live in a state with an estate tax, refer to your state’s law to understand the total impact.
The estate tax is a marginal tax like personal income taxes. That means that as your estate’s taxable value increases, the tax rate that applies to it increases. However, the estate tax rate increases more quickly than personal income tax. It starts at 18% for taxable values up to $10,000, then goes to 20% on the next $10,000. After that, it increases by 2% for every additional $20,000 of estate value on estates worth up to $100,000. It continues to rise until eventually capping at 40% on estates over $1 million.
Your estate isn’t liable for any tax if it’s below a certain amount, called the exemption (or exclusion) amount. It works similarly to the standard deduction for your income tax: Only the amount above the exemption is taxable.
How the TCJA Impacted Estate Tax
The most significant way the TCJA affected estate tax was by doubling the exemption amount. In 2017, the last year before the TCJA became effective, the exemption amount was $5,490,000 per person. That means a married couple could leave an estate valued at $10,980,000 without owing any estate tax. In 2024, the IRS allows an estate exemption of $13,610,000 per person or $27,220,000 for a couple. That’s a major difference on its own, but it also affects estate taxes.
However, if this provision of the TCJA sunsets in 2025, that exclusion amount will revert to $5,490,000 per person (adjusted for inflation). That amount is still large enough that most people won’t be affected. But if you believe your estate will be larger than that, prepare now to minimize the impact.
Estate Tax vs. Inheritance Tax
The estate tax is often confused with an inheritance tax, but they’re two different taxes with separate rules.
An estate incurs and is responsible for paying estate taxes before the assets are distributed to beneficiaries. However, beneficiaries incur an inheritance tax and are responsible for paying it when they inherit assets.
There’s no inheritance tax at the federal level, and only six states have an inheritance tax.
How to Prepare for the Estate Tax Sunset in 2025
Several estate planning strategies could help you reduce your estate’s taxable portion before the end of 2025. Consider speaking with a trusted tax professional and financial planner about whether any of these strategies would be helpful in your situation.
Spend Down Your Assets
Perhaps the most obvious way to reduce your estate tax liability is to spend down your assets to reduce the size of your taxable estate. However, this also means you won’t have the assets to pass on. If you want to pass the assets’ value to your beneficiaries or need them for financial security in retirement, this may not be the right approach.
Donate to Charity
Gifts to charity generally aren’t taxable and reduce your estate. Gifting during your lifetime has the added benefit of letting you see your gift’s impact.
Take Advantage of the Annual Gift Exclusion
A more strategic approach would be to take advantage of the IRS’s annual gift exclusion. This allows you to give away up to $18,000 per person in 2024 without incurring any tax liability on the gift while also reducing your estate’s size. A couple can combine gifts and pass up to $36,000 per recipient each year.
Use the Lifetime Gift Exclusion
You may also use the lifetime exclusion amount to make larger gifts. Any gift above the annual exclusion limit reduces your lifetime exclusion amount, which is the same as the estate tax exemption. For example, if you gift $20,000 to one person in 2024, the $2,000 above the $18,000 annual exclusion limit would reduce your lifetime exclusion amount.
This strategy may allow you to pass more assets to your beneficiaries before the sunset provision reduces the gift/estate exclusion amount. However, while most experts believe gifts will be subject to the TCJA provisions in effect when a gift is made, the IRS hasn’t explicitly confirmed.
Place Assets in a Trust
Different types of trusts are available, each serving a specific purpose. One category of trust, called an irrevocable trust, removes assets from your estate and therefore shields them from estate tax. Depending on your goals, an irrevocable trust could be a good way to reduce your estate while avoiding probate and maintaining some control over how your assets are distributed.
Stay Informed of the TCJA’s Fate
While no action has been taken, Congress could decide to extend the TCJA, make its provisions permanent, or repeal it altogether. Accordingly, stay updated with current tax laws and understand how changes may impact your financial plan.
You don’t have to navigate legislative updates alone. A trusted tax advisor and a financial professional can offer personalized insights and guidance. Reach out to a Bankers Life representative today to learn how they can assist as you plan your future.
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