The Estate and Gift Tax Exclusion Shrinks in 2026. What's an Advisor to Do?

What You Need to Know

The federal lifetime gift and estate tax exclusion will increase for 2023, with possible increases for 2024 and 2025.
However, these high thresholds are only temporary, unless there is a change in tax law.
For clients with assets in excess of the exemption amounts after 2025, there are steps that can reduce their taxable estate.

The federal lifetime gift and estate tax exclusion will increase from $12.06 million in 2022 to $12.92 million for 2023. There could also be increases for inflation for both 2024 and 2025. That’s the good news.

The bad news for some wealthy clients and their advisors: Barring a change in tax law, these high thresholds are only temporary. Under the sweeping tax overhaul enacted in 2017, known as the Tax Cuts and Jobs Act, the increase in the exemption will sunset after 2025, sending the estate and gift tax exclusion back to its pre-2017 level of $5 million, adjusted for inflation. 

What Happens to the Lifetime Estate and Gift Tax Limits After 2025?

Estimates for tax year 2026 vary, but it is expected the amount will be as much as $6.8 million per person.

To be sure, most Americans do not have estates large enough to worry about these limits. But for high-net-worth clients who may be affected, there are important estate planning issues to consider.

Note we are only discussing the implications for the federal estate and gift tax exemption. Various states have their own estate and inheritance tax rules. 

What Is the Estate and Gift Tax Exclusion for 2023?

There is an annual estate and gift tax exclusion that is adjusted each year for inflation. Gifts at or below that amount do not count toward the lifetime exemption. For 2022, the annual exclusion is $16,000 to any single recipient. For 2023, this increases to $17,000.

What if My Client Makes Gifts Before 2026?

For clients who have not made any gifts prior to 2026, their lifetime gift and estate tax exemption will revert to 2026 levels, with any increases in subsequent years applying. If they have made gifts prior to 2026, there could be a couple of scenarios. 

If the amount of their gifts was less than the exemption amount in place in 2026 or beyond, their remaining exclusion would be the amount of the exemption less the amount of their lifetime gifts. For example, if the exclusion is $6.8 million and they have given $3 million in lifetime gifts, their remaining exclusion would be $3.8 million. Gifts in excess of the exclusion would be subject to estate taxes.
If the amount of their gifts prior to 2026 exceeded the limit in place, the exemption from the old limits would apply to those gifts. However, they would have no additional exemptions. As an example, if your client had made $9 million in gifts prior to 2026, that would be their exemption amount upon their death. They would have no additional exemption amount for 2026 or beyond, unless the inflation-adjusted exemption were to exceed $9 million in the future. 

The higher exemption amounts currently in place are essentially “use it or lose it.” Any difference between the higher exemption amounts and the post-2025 reduced amounts will be lost if not used. However, any gifts made in excess of the higher exemption amounts in place prior to 2026 would still fall under the higher exemption upon your client’s death. 

How Can My Clients Reduce Their Estate Taxes?

For clients with assets in excess of the exemption amounts that will be in place after 2025, there are some steps they can take to reduce their taxable estate and/or take advantage of the current limits. What is best for a particular client will vary based on their own unique situation including the nature of their heirs, marital status, their own health situation and a host of other factors. 

Estate Tax Reduction Strategy: Spend Down Assets

One solution is to encourage your client to spend down some of their assets. This does not mean frivolous, indiscriminate spending but rather encouraging them to enjoy their money. Go on that around-the-world vacation they’ve always wanted to take. Travel to out-of-town sporting events or to attend theater performances. Dine at those top-notch restaurants. 

Depending on how large their estate is, their age and health, this type of spending may not get their estate under the future exemption limits, but these expenditures can add up over time and fit with an overall plan. Many people who have accumulated large asset bases tend to be frugal. Encourage your clients to enjoy the fruits of their hard work and diligent savings and investing habits. 

Another Tax-Smart Strategy: Give to Charity

For clients who are charitably inclined, gifts to charity are an excellent way to reduce the size of their taxable estate. Current-year gifts of cash, appreciated securities and other assets can provide a tax deduction that can be used to reduce current-year income taxes in addition to reducing assets. Clients can also avoid having to pay capital gains taxes on the sale of these holdings. 

For clients who wish to benefit one or more charitable organizations over time, a donor-advised fund (DAF) might be a good solution. A DAF allows your client to make an upfront deductible contribution to a managed account and then parcel out donations to eligible charities over time. They can make a series of deductible contributions over time, this can allow them to take a measured approach to charitable giving as a way to reduce their taxable estate. 

Gifting appreciated securities provides several benefits. They can receive a current year deduction based on the market value at the time of the gift. They would not incur any capital gains taxes as they would have if the securities were sold. And the donation reduces the size of their estate. 

Marriage and Estate Taxes

Married couples have double the individual lifetime estate and gift tax exemption. For 2023 this would mean that a married couple has a combined exemption of $25.84 million. With a few exceptions, assets can be left to a surviving spouse on an unlimited basis with no estate tax consequences. One exception is that a non-citizen spouse cannot benefit from the unlimited marital deduction rules.

There are a number of estate planning opportunities available for married clients. One option is that a surviving spouse can take advantage of a deceased spouse’s unused lifetime exclusion in some cases. This can allow the surviving spouse to leave a larger amount to their heirs than just their own lifetime gift and estate tax exclusion would allow.