The estate tax is a tax levied on the transfer of assets from a deceased person’s estate to their heirs. The federal estate tax rate is currently set at 40%, which can significantly reduce the amount of wealth that passes on to your loved ones.
However, there are exemptions and credits available that can help reduce or eliminate the impact of the estate tax. One such exemption is the 2023 estate tax exemption, which will be implemented in 2023 and will have a significant impact on estates.
In this article, we’ll dive deep into what the 2023 estate tax exemption is, how it works, and how it affects individuals with larger estates.
What Is the 2023 Estate Tax Exemption?
The 2023 estate tax exemption is a provision of the Tax Cuts and Jobs Act (TCJA), which was signed into law in December 2017. This provision increases the amount of money an individual can pass on to their heirs without being subject to federal estate taxes.
Prior to this provision, the federal estate tax exemption was increased incrementally each year from $5 million in 2011 to $5.49 million in 2017. However, with the implementation of the TCJA, the federal estate tax exemption doubled from $5.49 million per person to $11.18 million per person in 2018.
This new limit applies until December 31st, 2025 when it will revert back to pre-TCJA rates if Congress doesn’t act before then. After December 31st, 2025, the federal estate tax exemption is expected to decrease by half – to around $6 million per person – unless Congress changes these laws again.
How Does It Work?
Under current law, any assets you leave behind when you die are valued for their fair market value at the time of your death. If the total value of these assets exceeds the estate tax exemption limit, your estate will be subject to estate taxes.
The amount of estate tax you’ll have to pay depends on the total value of your estate and how much it exceeds the exemption limit. Anything above that limit is taxed at a rate of 40%.
For example, if an individual dies in 2023 with an estate valued at $12 million and had no prior taxable gifts, their taxable estate would exceed the new threshold by $830,000 ($12 million – $11.17 million). The federal estate tax owed would be approximately $332,000 (40% x $830,000).
However, if that same person died in 2022 with an estate also worth $12 million but before the effective date of the new law, their taxable estate would exceed the then-applicable threshold by $6.51 million ($12 million – $5.49 million), and they would owe roughly $2.6 million (40% x $6.51 million) in federal estate taxes.
Who Is Affected?
The 2023 estate tax exemption primarily affects individuals with larger estates that are worth more than the exemption limit.
According to 2019 data from Credit Suisse Research Institute’s Global Wealth Report, only about 0.1% or one out of every thousand people globally have a net worth above $50 million.
Therefore, only a small percentage of people will be affected by this change in law; however, these individuals may face significant changes in their financial planning as they need to account for any adjustments made to this law.
How Can You Plan for This Change?
If you have a larger net worth and believe that you’re likely to be impacted by this change in law or you’re currently undertaking wealth management activities such as gifting or setting up trusts for beneficiaries needing special consideration due to disability or other factors, you may need to reevaluate your estate plan in light of these changes.
One thing you can do is consult with a financial advisor or estate attorney to assess your current estate plan and see if any changes are necessary. They can advise you on possible strategies that could help reduce the impact of estate taxes and protect your assets for future generations.
Possible strategies include making gifts during your lifetime or setting up trusts that provide income to beneficiaries while preserving the principal amount of the gift. Life insurance policies can also be used as an effective way to provide liquidity for an estate tax bill, essentially creating a "tax-free" pool of funds to pay any taxes owed.
The 2023 estate tax exemption will have significant consequences for larger estates in the years ahead. Although only a small percentage of individuals are likely to be affected by this change, those who are will need to take action now to ensure that their assets are protected for future generations.
If you’re concerned about how this change will affect your estate planning, we encourage you to speak with a financial advisor, CPA or attorney who can help guide you through the process and identify some potential strategies. Don’t wait until it’s too late – start planning now!
What is the 2023 estate tax exemption?
The 2023 estate tax exemption is the amount of money that an individual can pass on to their heirs without having to pay federal estate taxes. As of now, it is set to be $5.93 million