Last week’s federal election results place a Republican in the White House and shift control of the Senate and the House to the Republican Party. What does this all mean for the future of estate planning, particularly for steps that should be considered today?
Estate Tax Exemption
The federal estate tax exemption will be $13.99 million in 2025. I believe it will likely remain on its inflation-adjusted course for at least four more years rather than sunset in 2026, as provided under the Tax Cuts and Job Acts. Especially given the fact that significant gifting strategies, including gifts to a so-called spousal limited access trust, have similarly significant disadvantages associated with them, including a loss of income tax basis step-up on the transferred assets on the death of the transferor, practitioners will need to re-examine these strategies, and potentially put them on hold, in all but the largest estate situations (in which the gifts have likely already been made).
When combined with the existence of the spousal portability election (where a surviving spouse can, in effect, elect to add a predeceased spouse’s inflation-adjusted estate tax exemption onto their own), the families of married couples with combined taxable estates of $28 million or less can be significantly damaged, on an after income and estate tax basis, by the couple making unnecessary significant lifetime gifts of appreciated assets. It’s possible that a single individual with an estate of less than $14 million or a married couple with an estate of less than $28 million would save $0 in federal estate taxes for their family by making large lifetime transfers of appreciated assets but would instead cause the family members to eventually pay significant capital gains taxes when they eventually sell the gifted assets.
Income Tax Rates
Another tax benefit that should now remain for at least four more years is the lower federal income tax rates, which are currently in place. One important tax strategy this presents is in the area of individual retirement account Roth conversions. Especially for retired individuals, converting taxable IRA and Internal Revenue Code Section 401k plan benefits to nontaxable Roth IRAs over a 4-year or longer period rather than all before 2026 can produce significant long-term income tax benefits for the account owner, especially knowing that federal income tax rates will likely rise in the long-term. Proceeding in this tax-wise fashion will also produce significant after-tax benefits for the account owner’s spouse and other heirs.
A related option is converting some of the individual’s taxable IRA or Section 401k funds to nontaxable life insurance. The additional tax benefit this option creates derives from the fact that it’s currently still possible to have the life insurance policy owned outside of the individual’s taxable estate, for example, by the individual’s children or by an estate tax-exempt life insurance trust for the benefit of the individual’s spouse and descendants. If the large estate tax exemption sunsets at some future date, by converting all or a portion of the taxable IRA or Section 401k benefits to life insurance in the near term, the income tax-exempt life won’t cause a loss of income tax basis step-up to the individual’s family, because the life insurance proceeds are received by the family members income tax-free.
Structuring Trusts
In light of the beneficial elements described above, when drafting trusts for a surviving spouse and descendants, it’s essential to build into the trust agreement the potential to create an income tax basis step-up at the death of the trust beneficiary, to the extent this won’t cause an estate tax liability at the death of the beneficiary or the beneficiary’s surviving spouse. The trust agreements should also be structured to intentionally cause the income of the trusts to be taxed at the beneficiary’s federal income tax rates, as long as these rates remain lower than the federal income tax rates applicable to trusts.
Practitioners should also consider modifying existing irrevocable trusts, either under the state’s “trust decanting” rules or under a similar provision included in the trust agreement itself, to achieve the above-desired income tax benefits for the existing trust and its beneficiaries. For example, an existing irrevocable trust might be modified to create an income tax basis step-up at the death of the trust beneficiary or to cause the income of the trust to be taxed at the individual beneficiary’s lower federal income tax rates rather than at the high trust federal income tax rates.
Revised Thinking
The above recommendations represent only a few areas where last week’s federal elections will affect estate planning. The results of the elections, and in particular what they’ll likely mean for the federal estate tax exemption and income tax rates over at least the next four years, necessitate that practitioners re-examine current plans for large lifetime gifts and explore all available techniques for leveraging the current low federal income tax rates.