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2023 Year-End Estate Planning Update: Time to Act Now


8 minute read

2023 Year-End Estate Planning Update: Time to Act Now

The year-end estate planning climate presents significant challenges – as well as opportunities – for wealthy individuals and families alike. The 2024 transfer tax exemption will remain at a historically high level, and no significant legislation was enacted over the past year impacting estate and gift taxes. Although future legislation remains uncertain, there are a variety of strategies available that taxpayers can use to take advantage of current exemption levels. The most significant legislative update is the Corporate Transparency Act going into effect January 1, 2024, which will create a reporting requirement that many entities must address or risk facing penalties.

Current transfer tax laws

The federal gift, estate, and generation-skipping transfer (GST) tax exemptions (i.e., the amount an individual can transfer free of such taxes) were $12.92 million per person in 2023 and will increase to a historic $13.61 million in 2024. Beginning in 2024, a married couple can transfer up to $27.22 million free of federal transfer tax. The transfer tax exemption will be adjusted upward for inflation in 2025, but under current law is scheduled to be reduced by 50% on January 1, 2026.

A “marital deduction” is allowed for assets passing directly to (or in qualifying trusts for) the benefit of a surviving spouse, and a charitable deduction is allowed for assets passing in a qualifying manner to charity. The federal tax rate on any assets above the transfer tax exemption (that do not qualify for the marital or charitable deduction) is a flat 40%. The federal transfer tax exemptions can be used either during lifetime or at death. Using exemption during lifetime is generally more efficient for transfer tax purposes, as any appreciation on the gifted assets escapes estate taxation.

The Treasury Department has confirmed that the additional transfer tax exemption granted under current law until 2026 is a “use it or lose it” benefit, and that if a taxpayer uses the “extra” exemption before it expires (i.e., by making lifetime gifts), it will not be “clawed back” causing additional tax if the taxpayer dies after the exemption is reduced in 2026. This means that a taxpayer who has made $6.805 million or less (adjusted for inflation) of lifetime gifts before 2026 will not “lock in” any benefit of the extra exemption, while a taxpayer who makes use of the additional exemption before 2026 (e.g., by making gifts of $13.61 million before 2026) will “lock in” the benefit of the extra exemption.

The Illinois estate tax exemption remains at $4 million per person, as this exemption does not receive an annual inflationary increase. Similar to the federal estate tax, marital and charitable deductions are allowed for assets passing directly or in qualifying trusts for the benefit of a surviving spouse for Illinois estate tax purposes. Thereafter, the effective marginal tax rate for assets above the Illinois estate tax exemption ranges from 8% to approximately 29%.

As with income taxes, state estate taxes are deductible for federal estate tax purposes. The cumulative federal and Illinois estate tax rate (for estates above both the federal and Illinois exemptions), taking deductions into account, is approximately 48%.

Federal tax laws allow for an “annual exclusion amount” that can be gifted from any one person to any other person in any given year without using up any estate/gift tax exemption. This amount increased to $18,000 per donee in 2024 (as the result of an inflation adjustment).

Lifetime transfer strategies

Taxpayers should strongly consider lifetime gifting strategies. As the estate/gift tax exemption is still scheduled to be reduced by 50% in January 2026, even if Congress does nothing, taxpayers who have not used the “extra” exemption before then will lose it forever. Furthermore, any post-appreciation transfer on gifted assets accrues outside of the taxpayer’s estate. This is especially salient for younger individuals and for transferred assets with high potential for appreciation. Finally, for taxpayers who live in states with a state estate tax but no state gift tax (such as Illinois), lifetime gifting may have the effect of reducing state estate tax liability.

Planning for basis change

Good estate planning incorporates income tax and other considerations rather than focusing myopically on estate and GST taxes. In general, upon an individual's death, the cost basis of any assets that are included in his or her gross estate for estate tax purposes receive an adjustment to their fair market value at the date of death. For appreciated assets, this can result in substantial income tax savings. Assets that are not included in the gross estate, however, do not receive a basis adjustment. Therefore, there is often a tradeoff between making lifetime gifts (to reduce estate taxes, but with the donee receiving the donor's “carry over” basis) and keeping assets in the gross estate (to obtain the basis adjustment and reduce income taxes). Fortunately, there are a number of techniques to help plan for possible change in basis while still retaining estate tax benefits. Irrevocable trusts that receive lifetime gifts can be structured to allow for a possible basis change. One way to do so, is by including a broad distribution standard in the trust agreement by which an independent trustee can make distributions out of the trust to the beneficiary. Additionally, a trust can be structured to grant an independent trustee the power to grant (or not grant) the beneficiary a “general power of appointment,” which would cause the trust assets to be includible in the beneficiary's estate for estate tax purposes and therefore receive the basis adjustment. Finally, if an irrevocable trust is structured as a grantor trust, the grantor can retain a “swap power” that can be used to transfer high basis assets to the trust and take back low-basis assets, in order to obtain the largest possible “step up” in basis.

The Corporate Transparency Act

Beginning on January 1, 2024, domestic and foreign entities registered in the United States will be required to report beneficial ownership information to the Financial Crimes Enforcement Network (FinCEN) under the Corporate Transparency Act (the CTA). FinCEN will be collecting this ownership information and creating a domestic beneficial ownership database (which under current law will not be available to the general public).

“Reporting Companies” will be required to report the full legal name, birthdate, residential address, and a unique identifying number from a passport or driver’s license (along with a copy of the passport or driver’s license), for any owner who directly or indirectly (i) owns at least 25% of the ownership interests or (ii) directly or indirectly exercises “substantial control” over the entity. Reporting Companies are domestic entities created by filing with the Secretary of State or foreign entities registered to do business with the Secretary of State (e.g., corporations, LLCs, limited partnerships), subject to certain exemptions.

There are 23 exemptions to the CTA reporting requirement, which include exemptions for large operating companies, inactive entities, banks, tax-exempt entities, charitable trusts, pooled investment vehicles, and subsidiaries of certain exempt entities. Entities are responsible for keeping track of their own exemption status.

An entity is considered a “large operating company” if the entity (i) employs more than 20 full-time employees in the United States, (ii) has a physical operating presence in the United States, and (iii) filed a federal income tax or information return for the previous year demonstrating more than $5,000,000 in gross receipts or sales.

An entity is considered to be “inactive” if it (i) was in existence on or before January 1, 2020, (ii) is not engaged in active business, (iii) is not owned directly or indirectly by a foreign person, (iv) has not experienced any change in ownership in the preceding twelve (12) month period, (v) has not sent or received any funds in an amount greater than $1,000, and (vi) does not hold any kind or type of assets in the United States or abroad.

Under the CTA, an individual is considered to have “substantial control” over an entity if the individual (i) serves as a senior officer, (ii) has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body), or (iii) directs, determines, or has substantial influence over important decision making. The CTA also provides a catch-all for individuals who have any other form of substantial control over an entity.

Although a trust is generally not a reporting company under the CTA, if an ownership interest of a Reporting Company is held in trust, beneficial ownership information may have to be reported for: (i) a trustee or other individual with the authority to dispose of trust assets; (ii) a beneficiary who is the sole permissible recipient of income and principal from the trust or has the right to demand a distribution of or withdraw substantially all of the assets from the trust; or (iii) a grantor or settlor who has the right to revoke the trust or otherwise withdraw (or swap) the assets of the trust.

FinCEN currently has three different reporting deadlines depending on the entity formation date:

  • Entities in existence by December 31, 2023 will have until December 31, 2024 to comply with the reporting requirement;
  • Entities formed between January 1, 2024 and December 31, 2024 will have 90 days from formation to comply with the reporting requirement; and
  • Entities formed on or after January 1, 2025 will have 30 days from formation to comply with the reporting requirements.

If there is a change in ownership, or there is a change in previously reported beneficial ownership information (e.g., if an owner’s residential address changes), the entity is required to report such changes to FinCEN within 30 days of such change. In other words, there are continuing reporting obligations. The reporting obligations are imposed on the Reporting Company itself, with substantial penalties for noncompliance. FinCEN has not yet issued a final form to comply with these requirements, but expects to on or before January 1, 2024, with the launch of their Beneficial Ownership Secure System on the FinCEN website.

Please reach out to the authors of this alert or another member of our Estate Planning & Wealth Transfer group to evaluate your circumstances and determine appropriate strategies that fulfill your estate planning objectives. We look forward to working with you in the new year.