Understanding Federal Tax Exemptions: A Guide to Estate, Gift, and Generation-Skipping Transfer Taxes

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“The Population Division of the Bureau of the Census estimates that about 2.8 million people died in 2022.  Thus, an estate tax return will be filed for only about 0.25 percent of decedents, and only about 0.14 percent will pay any estate tax in 2023.”  That number is about to change drastically.

Overview of the Federal Estate, Gift, and Generation-Skipping Transfer Tax Exemption

The Tax Cuts and Jobs Act of 2017 made significant changes to the Internal Revenue Code, most notably by doubling the federal estate, gift, and generation-skipping transfer (GST) tax exemption from $5,490,000 in 2017 to $11,180,000 in 2018.  Due to inflation and the cost of living, this exemption has since been scaled up and increased to $13,610,000 in 2024.  However, on January 1, 2026, the exemption is set to sunset and revert to $5,000,000, which when adjusted for inflation will amount to approximately $7,000,000, unless Congress takes action before then.

• Estate Tax

The estate tax is a tax applied to your right to transfer property upon your death.  The exemption is the maximum amount of assets a person can pass on to their heirs at death without triggering federal estate taxes.  It involves an assessment of everything you own or have certain interests in as of the date of your death, using Form 706.  The valuation is based on the fair market value of these assets, constituting your “Gross Estate.”  The assets included may range from cash and securities to real estate, insurance, trusts, annuities, business interests, and other possessions.  As of January 1, 2011, estates of deceased individuals who are survived by a spouse may choose to transfer any unused portion of the decedent’s exemption to the surviving spouse.  This choice must be made on a timely filed estate tax return for the decedent with a surviving spouse.  Federal and state estate taxes are deducted from your estate’s assets before distributing the remaining assets to your heirs.  The executor or trustee is responsible for filing the required federal and state estate tax returns and ensuring that all taxes are paid from the estate.  Form 706, the federal estate tax return, must be filed within nine months of the decedent’s date of death, with a possible extension of six months.  Any estate tax payment due should be made by the original deadline unless the IRS has approved a payment extension.

• Gift Tax

The federal gift tax exemption is the total amount an individual can give to others during their lifetime without being subject to the gift tax.  The gift tax is levied on the transfer of property from one individual to another when the giver receives nothing, or less than the full value, in return.  This tax applies whether or not the donor intends for the transfer to be classified as a gift.  The IRS allows individuals to give a certain amount of assets or property tax-free each year.  For 2024, the annual gift tax exclusion is $18,000, enabling a person to give up to $18,000 to any number of recipients without incurring gift taxes.  If you exceed the annual gift tax limit, you must file a gift tax return with the IRS, and the amount to exceed the annual gift tax limit goes towards your annual lifetime exclusion, which is currently set at $13,610,000 in 2024.  If you are married, you and your spouse can each gift up to $18,000 in 2024 without needing to file a gift tax return in 2025.  In order to give someone a total of $36,000, spouses can use “gift splitting” to combine annual exclusions. Gifts between spouses are unlimited and typically do not require the filing of a gift tax return.

• Generation- Skipping Transfer Tax (GST Tax)

The GST tax is a federal tax on transfers of assets or property to individuals, or trusts benefiting them, who are more than one generation removed from the transferor.  This includes transfers from a grandparent to a grandchild or individuals more than 37 1⁄2 years younger than the transferor (the “skip” generation).  The GST tax is imposed at the highest federal gift and estate tax rate in effect at the time of the transfer, which is 40% in 2024, and is additional to any other federal gift or estate taxes that might be owed.  Each U.S. resident has a lifetime GST tax exemption of $13.61 million, or $27.22 million for a married couple.  This allows a married couple to transfer up to $27.22 million to a skip person without paying GST tax.  However, this exemption is not independent; transfers to a skip person may also be subject to gift and estate taxes alongside the GST tax.

The GST tax was established in 1976 to address concerns that wealthy families were evading estate taxes by passing assets through trusts across multiple generations.  Before this tax, it was possible to transfer unlimited amounts of assets to a trust for future generations, thus avoiding estate taxes as each generation passed away.

Advanced Planning For the Future of the Estate, Gift, and GST Tax Exemption

Estate planning techniques can be implemented in order to take advantage of the large exemption amount before it almost halves in 2026 to around an estimated $7,000,000.  These techniques include trusts, limited liability companies, and more. 

• Spousal Lifetime Access Trust (SLAT)

A  (SLAT) is an irrevocable trust created by each spouse for the benefit of the other.  The donor spouse contributes gifts to the trust and permanently gives up any rights to those assets.  The beneficiary spouse, as well as other beneficiaries such as children or grandchildren, can access the gifted assets right away.  Since the trust is irrevocable, its assets are safeguarded from creditors and potential legal claims. A SLAT can reduce the couple’s combined estate. 

• Qualified Personal Residence Trust (QPRT)

A Qualified Personal Residence Trust (QPRT) enables you to exclude your primary or secondary home from your taxable estate while maintaining full possession and use of the property.  Upon your death, the residence is passed on to your designated beneficiaries.  Although this method is effective in lowering your taxable estate, it can be challenging if you decide to sell the property within the trust.

• Legacy Trust

A Legacy Trust, also known as a dynasty trust, is an irrevocable trust set up to hold and protect assets given to children, grandchildren, or others.  The beneficiary may act as the trustee, or another trustee can manage the trust either indefinitely or until the beneficiary reaches a specified age.  A legacy trust can contain a wide range of assets, from traditional investments to specialized holdings like real estate, family businesses, closely held business interests, and oil and gas interests.  The trust can even be funded with cash.

• Irrevocable Life Insurance Trust (ILIT)

An ILIT is distinctive because it holds and benefits from a specific type of insurance policy.  This policy, maintained within the trust, offers a guaranteed level of premium and death benefit and can be taken out on the life of one or both spouses.  The proceeds from the policy are not subject to estate taxes and can be utilized to cover estate tax obligations.  Creating an ILIT allows you (the grantor) to transfer taxable assets from your estate into a separate legal entity (the trust).  The trustee—who may be a friend, family member, or independent professional—uses these assets to buy a life insurance policy in your name and continues to pay the premiums to keep the policy valid.  When you pass away, the death benefit from the policy goes directly to the trust, which then distributes the funds to your designated beneficiaries. 

• Limited Liability Companies (LLC)

An LLC is a business entity created under state law, often employed for tax-efficient estate planning and asset protection.  Members of the LLC are shielded from personal liability for the company’s debts.  Furthermore, assets held by the LLC can be consolidated and leveraged for wealth transfer purposes.  Parents who create a family LLC with their children can keep control over their assets, reduce the estate taxes their children will face on their inheritance, and distribute the inheritance during their lifetime, all while minimizing gift taxes.

Conclusion on How to Use Advanced Planning for Estate, Gift, and GST Tax Purposes

Each of the discussed planning techniques can be used in various ways to minimize tax liability within the coming years.  However, it is important to realize that with high net worth estates, the years 2024 and 2025 are crucial in capturing the high exemptions, if possible.  While the high exemption amount only pertains to a small population of the United States currently, there will be many more taxable estates in 2026 if the law is not changed.  Therefore, if you have concerns about a taxable estate, it is crucial to consider speaking to an advanced estate planning attorney.