What Isn’t Taxable Today Could Be Taxable Tomorrow: Preparing for Changes in 2026
As 2026 approaches, it's crucial for advisors to discuss upcoming changes in estate taxes with their clients. The Tax Cuts and Jobs Act (TCJA) significantly raised the federal estate tax exemption to an impressive $10 million per individual, adjusted for inflation. However, this exemption may sunset, meaning that what isn’t taxable today could soon be taxable.
A Brief History of the Estate Tax Exemption
Understanding the history of the estate tax exemption provides context for ongoing debates about its future. The federal estate tax was first introduced in 1916 to help fund the government. Over the years, the exemption limits and rates have fluctuated significantly.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) incrementally raised the estate tax exemption while lowering the tax rate, ultimately eliminating it in 2010. However, the tax was set to revert to 2001 levels for deaths occurring in 2011 unless Congress intervened. In 2011, the exemption was reinstated at $5 million.
Legislative Purpose
The TCJA was enacted in 2017 to boost economic growth and job creation. A key component of this strategy was to double the estate tax exemption from $5.49 million to nearly $11 million. By 2024, this amount will be adjusted to $13.61 million, allowing individuals to pass on considerable wealth tax-free.
The TCJA’s Sunset Provision
The TCJA includes a sunset provision that stipulates the increased estate tax exemption, projected to reach $13.61 million in 2024, will expire on December 31, 2025. If no legislative action is taken, the exemption will revert to the 2017 limit of $5 million, adjusted for inflation. According to the Congressional Budget Office, this will likely mean an exemption of about $6.4 million in 2026. This shift could pose significant challenges for high-net-worth families who previously were not impacted by estate taxes. It’s crucial for these individuals to prepare for both possibilities as soon as possible.
Why the Current Estate Tax Exemption Might Persist
Keeping the high estate tax exemption could be viewed as a benefit for the wealthy, shifting the tax burden onto others, while also preserving the existing landscape. As it stands, most individuals are exempt from federal estate taxes due to the current law.
The higher exemption was designed to stimulate economic growth and capital investment, enabling affluent individuals and families to reinvest their wealth into businesses and job creation. However, the federal government also relies on estate tax revenue to fund various programs and initiatives, making it unlikely they would willingly forgo such a lucrative source of income. Without the estate tax, alternative revenue streams would need to compensate, potentially leading to cuts in public benefits and services.
For the higher estate tax exemption to remain beyond 2025, Congressional action will be necessary.
Reasons the Estate Tax Exemption Might Decrease
The TCJA was crafted as a short-term tax cut initiative. To accommodate these tax reductions, lawmakers temporarily raised the estate tax exemption.
Advocates for reverting to a lower exemption argue that this change could enhance revenue by increasing the number of taxpayers affected and extending estate tax liabilities to those with wealth above the current threshold. This means individuals with estates valued below $10 million might again find themselves subject to federal estate tax laws. Revenue from estate taxes is expected to rise significantly after 2025, with combined estate and gift tax revenues projected at $372 billion from 2021 to 2031.
Emphasizing the Role of Trusted Advisors
As we approach 2024, it’s essential to keep clients informed about potential changes to the federal estate tax exemption and help them prepare for various scenarios. Encourage them to review their estate plans to safeguard their assets and preserve their financial legacy. There are multiple strategies available to navigate potential estate taxes effectively.
Advise your clients to make informed decisions based on the current legal landscape before 2025, while also staying alert for future developments. Preparation can offer families new planning opportunities and peace of mind, regardless of whether the exemption stands at $6.4 million or $13.6 million, as both amounts still provide a buffer against estate taxes.