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Depending on the results of this year's November elections, on January 1, 2026, if not earlier, the federal estate and gift tax exemption, which currently stands at $13.6 million, may revert to its previous level when, adjusted for inflation, it will likely be less than half this amount, or less than $6.8 million. This newsletter will introduce some of the steps clients may wish to consider taking, now, in light of the potential sunset of the high federal estate and gift tax exemption. We apologize in advance if portions of this newsletter are of a technical variety.
Note that this newsletter is not intended to provide complete and thorough tax or legal advice, but only to introduce our clients to the subject matter. Further discussions are necessary to provide the best advice applicable to each client's situation.
Married Couples
Estates of Less Than $6 Million
Married couples who anticipate that the value of their combined estate (including life insurance proceeds and IRAs and other retirement plan benefits) will be less than $ million need not be concerned with the upcoming scheduled sunset of the current high federal estate tax exemption. If the couple resides in a state that has a lower estate tax exemption, however, such as Illinois (which currently has a $4 million exemption), and they anticipate that the combined value of their estate will exceed the state's estate tax exemption, they should ensure that they have taken appropriate steps to avoid the state estate tax, by dividing their assets between themselves and establishing estate-tax-exempt trusts for the surviving spouse. This technique is described in more detail in the following section.
Estates in Excess of $6 Million but Less Than $12 Million
Married couples who anticipate a combined taxable estate (including life insurance and IRA and other retirement plans benefits) in excess of $6 million but less than $12 million should consider taking steps to ensure that their families will not pay unnecessary estate taxes if and when the current favorable estate tax laws expire. For example, a married couple with a combined estate of $8 million may want to “balance” their two estates, so that the surviving spouse will not have more than $5 million in his or her name (including jointly-owned property and IRA and other retirement plan benefits passing to such spouse at the first spouse's death), and so that first spouse to die leaves his or her separate estate at death in an estate-tax-exempt trust for the survivor. By planning in this fashion, the couple can ensure that they will avail themselves of up to two $6 million federal estate tax exemptions, or $12 million total, if the current favorable estate and gift tax law sunsets.
A similar but even more pressing analysis applies to residents of states which impose a separate estate tax. For residents of Illinois, for example, this type of special planning for a married couple is necessary if the couple anticipates that their total estate will be $4 million or more.
It is important to note that waiting until the current estate tax laws sunset, before planning for the possibility of a $6 million exemption in 2026 or earlier, may not turn out to be sufficient. For example, if a married couple currently has a combined estate of $8 million, and one of the spouses passes before the laws change, a surviving spouse who remarries and who lives until after the laws change may only be entitled to one, smaller estate tax exemption.
Estates of $12 Million or More
Prior to the November election, married couples anticipating a combined taxable estate in excess of $12 million (including life insurance proceeds and IRA and other retirement plan benefits) may wish to begin exploring options for “grandfathering” the larger exemption amount.
How Grandfathering Works
An individual must gift away more than the anticipated 2026 exemption amount before any grandfathering of the larger estate and gift tax exemption will begin to occur. Total lifetime gifts of no more than the anticipated smaller, 2026 exemption amount will not cause any grandfathering of the exemption, because the grandfathered amount is only the incremental amount of the aggregate lifetime taxable gifts in excess of the lower exemption amount. Thus, for example, if an individual gifts $6 million away during his lifetime, none of the current larger exemption amount will have been grandfathered, and potentially $8 million or more of estate and gift exemption will have been lost.
In order to avail themselves of the larger estate and gift tax exemption amount, many couples will want to explore establishing a so-called irrevocable spousal limited access trust, or “SLAT,” the considerations of which were discussed in Jim's 2020 article, “Timely Considerations for the Double Spousal Access Trust.” Under a SLAT, one spouse establishes an irrevocable estate-tax-exempt lifetime trust for the other spouse, with assets equal in value to up to the $13.6 million estate and gift tax exemption (less prior taxable gifts). The “transferor spouse” is then said to indirectly enjoy the benefits of the trust during the “transferee spouse’s” lifetime.
The Double Spousal Access Trust, or “DSAT,” is a technique whereby the couple can “double” the advantage of a SLAT by having the transferor spouse transfer both spouses’ estate and gift tax exemption amounts (or approximately $27.2 million, less prior taxable gifts) to a single trust for the transferee spouse, thereby making all of the trust assets available to the couple during their marriage. A potential problem with the DSAT arises, however, if the transferee spouse predeceases the transferor spouse, as the trust assets cannot then revert for the benefit of the transferor spouse.
In an effort to respond to this concern, clients can look to establish two SLATs, one by each spouse, with the other spouse being the beneficiary of each. In doing so, however, the couple will need to avoid the so-called “reciprocal trust doctrine” first articulated by the Supreme Court 55 years ago, in United States vs Estate of Grace. According to the Supreme Court, the two trusts should be unwound by the IRS if the trusts are “interrelated, and that the arrangement, to the extent of mutual value, leaves the settlors in approximately the same economic position as they would have been in had they created trusts naming themselves as life beneficiaries.”
Avoiding Grace
There are three prongs to the Supreme Court’s decision in Grace, all three of which appear to be requirements for uncrossing two trusts, thus causing the assets of the trusts to be fully includible in the spouses’ gross estates for federal estate tax purposes.
The first prong is the “interrelated” trust component. Clients can minimize the chance of this prong applying by establishing and funding one of the two SLATs in 2024 and the other in 2025, but before the laws change. One problem with relying on this type of planning, however, is that the IRS can still argue that, even though there is a substantial period of time between the establishment and funding of the two trusts, the trusts are nevertheless established as part of an” interrelated” plan. Another potential problem is that, depending on the results of the upcoming election, Congress could act quickly in 2025 to accelerate the sunset of the existing high estate and gift tax exemption.
The second prong to Grace is the “to the extent of mutual value” component. Under this prong, if spouse #1 establishes an irrevocable trust for spouse #2 with $13 million of assets, and spouse #2 establishes an irrevocable trust for spouse #1 with $10 million of assets, only the first $10 million of assets in each trust can be uncrossed by the IRS. This conclusion will only be modestly comforting to the couple, in most instances.
The third and final prong of Grace is that the trust arrangement “leaves the settlors in approximately the same economic position as they would have been in had they created trusts naming themselves as life beneficiaries.” Oxford defines the verb “approximate” as “to come close in quality or quantity,” words that can obviously become subject to varying interpretations when applied to specific facts. Thus, even if the two trusts are structured differently so that, although the spouse is a current beneficiary of each trust, there are other differences in the two trust agreements, it may never be possible to say, with certainty, that the interests of each spouse in the respective trusts do not “come close in quality or quantity.”
One technique which logically should ensure that the arrangement fails the third prong of Grace is to not make each spouse an immediate, or even close to immediate (as in the 2024 and 2025 trusts example already described), beneficiary of the other spouse’s trust. Thus, for example, one spouse could make the other spouse an immediate beneficiary of Trust #1, while in Trust #2 the spouse names the couple’s descendants as the immediate beneficiaries of the trust, with the settlor spouse of Trust #1 only becoming a beneficiary of Trust #2 in the event of the death of the settlor spouse of Trust #2. By proceeding in this fashion, the settlors are not left in approximately the same economic position as they would have been in had they created trusts naming themselves as life beneficiaries. Quite to the contrary, the settlor of Trust #1 may never be a beneficiary of either trust.
Single Individuals
Single individuals are not immune from the need for planning for the sunset of the current large estate and gift tax exemption. Especially in large estate situations, consideration should be given to grandfathering the current exemption by transferring up to $13.6 million in assets (after factoring in previous taxable gifts) to an irrevocable trust or trusts for the benefit of the individual’s heirs. [If the individual is a widow or widower, he or she may potentially also include in this gift his or her predeceased spouse's "unused" estate and gift tax exemption.]
Depending on the value of the assets retained by the individual, he or she may be able to access the assets of the transferee trust through loans which include adequate interest and security.
Update Meetings
If it has been three or more years since your last estate planning update meeting, we would recommend that you consider scheduling one at your nearest opportunity to discuss how the above and other changes in the law, in your financial situation, and/or in your personal situation may impact your estate planning.
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