What Is Federal Estate Tax Exemption, and Does It Matter?

Why should most of us be worried about losing an estate tax exemption, when most people’s estates are nowhere near $12.06 million? This recent article, “Don’t Throw Away a $12.06M Estate Tax Exemption By Accident” from Kiplinger explains it all.

Despite the Congressional gridlock over many estate tax issues, whether Congress moves forward or not, on January 1, 2026, the federal estate tax exemption will sink from $12.06 million to approximately $6 million. There was a Democrat proposal during the presidential campaign to reduce it even less, to $3.5 million.

Suddenly, the federal estate tax exemption will matter again to a lot more people. However, don’t wait for that 2026 date, since you could miss a big exemption.

If you are married and your spouse passes, you could take advantage of the current $12.06 million estate tax exemption, even if your estate is nowhere near this value. The exemption is a “use it or lose it” tax planning alternative. Use it.

In most estate plans, one partner leaves most or all of their estate to the surviving spouse. Assets left to a surviving spouse qualify for what is known as “an unlimited marital deduction.” If there is no taxable estate on the death of the first spouse because all assets have gone to the surviving spouse, who qualifies for the marital deduction, the deceased spouse’s unused exemption does not have to be lost.

A deceased spouse may transfer any unused portion of their exemption to the surviving spouse, known as “portability.” Many families may find themselves with an unnecessary tax burden in the near future, if they fail to take advantage of this because they think it won’t apply to them.

Consider a family with a $10 million estate, owned as community property, where each spouse owns one half. If one spouse dies tomorrow, the family probably thinks they don’t need to worry about the federal estate tax, as there’s $12.06 million exemption for the wife and $12.06 million exemption for the husband. However, this would be an expensive mistake.

If the family files a portability election on the timely—filed estate tax return for the first spouse to die, the second spouse’s lifetime exemption of $12.06 million goes to the second to die spouse’s estate.

If the second spouse lives to at least January 1, 2026, and the estate is worth $10 million, the taxable estate after the exemption is $4 million. With an estate tax of 40%, the estate tax liability is $1.6 million, which needs to be paid in full nine months after the date of death. The portability exemption could have prevented this tax liability.

A portability-only estate tax return can be filed up to two years from the date of death, which your estate planning attorney will be able to help you with. There is a fee for the filing, but the savings to be had make this a worthwhile fee to pay. Consider this a form of tax insurance. Any families with a net worth of $2 million or more should be talking now with their estate planning attorney about how to manage the changing estate tax exemption.

Reference: Kiplinger (April 14, 2022) “Don’t Throw Away a $12.06M Estate Tax Exemption By Accident”

When Should You Fund a Trust?

If your estate plan includes a revocable trust, sometimes called a “living trust,” you need to be certain the trust is funded. When created by an experienced estate planning attorney, revocable trusts provide many benefits, from avoiding having assets owned by the trust pass through probate to facilitating asset management in case of incapacity. However, it doesn’t happen automatically, according to a recent article from mondaq.com, “Is Your Revocable Trust Fully Funded?”

For the trust to work, it must be funded. Assets must be transferred to the trust, or beneficiary accounts must have the trust named as the designated beneficiary. The SECURE Act changed many rules concerning distribution of retirement account to trusts and not all beneficiary accounts permit a trust to be the owner, so you’ll need to verify this.

The revocable trust works well to avoid probate, and as the “grantor,” or creator of the trust, you may instruct trustees how and when to distribute trust assets. You may also revoke the trust at any time. However, to effectively avoid probate, you must transfer title to virtually all your assets. It includes those you own now and in the future. Any assets owned by you and not the trust will be subject to probate. This may include life insurance, annuities and retirement plans, if you have not designated a beneficiary or secondary beneficiary for each account.

What happens when the trust is not funded? The assets are subject to probate, and they will not be subject to any of the controls in the trust, if you become incapacitated. One way to avoid this is to take inventory of your assets and ensure they are properly titled on a regular basis.

Another reason to fund a trust: maximizing protection from the Federal Deposit Insurance Corporation (FDIC) insurance coverage. Most of us enjoy this protection in our bank accounts on deposits up to $250,000. However, a properly structured revocable trust account can increase protection up to $250,000 per beneficiary, up to five beneficiaries, regardless of the dollar amount or percentage.

If your revocable trust names five beneficiaries, a bank account in the name of the trust is eligible for FDIC insurance coverage up to $250,000 per beneficiary, or $1.25 million (or $2.5 million for jointly owned accounts). For informal revocable trust accounts, the bank’s records (although not the account name) must include all beneficiaries who are to be covered. FDIC insurance is on a per-institution basis, so coverage can be multiplied by opening similarly structured accounts at several different banks.

One last note: FDIC rules regarding revocable trust accounts are complex, especially if a revocable trust has multiple beneficiaries. Speak with your estate planning attorney to maximize insurance coverage.

Reference: mondaq.com (Sep. 10, 2021) “Is Your Revocable Trust Fully Funded?”