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Why Estate Tax Planning Needs to be Part of the Plan

You’ve created a solid financial roadmap, you’re saving for retirement and you’ve prepared all your estate planning documents. Great! But if you haven’t done estate tax planning—or if you haven’t reviewed your estate tax plans recently—you’re missing a core piece of the puzzle because without estate tax planning, taxes can take a significant percentage of your savings before your heirs get anything.

Why Estate Tax Planning Matters

The central goal of estate tax planning is to preserve assets and wealth during the transfer from one generation to the next. Because estate taxes only kick in when someone dies, it’s easy to see how so many people put this off; estate tax planning might not be part of the conversation with your tax preparer each year. But failing to plan for estate taxes can be an expensive mistake for several reasons. 

Your estate could owe a lot in state taxes. Some people might neglect estate tax planning because they assume it’s just for the extremely affluent. That’s not true, especially in Massachusetts and other states that impose their own estate taxes separate from the federal tax. Many estates fall below the federal estate tax exemption threshold ($11.7 million per individual for 2021) and don’t owe any federal estate taxes. In Massachusetts, which allows an estate tax exemption of just $1 million per person, dying with an estate valued above that threshold triggers an estate tax that maxes out at 16 percent. Unlike the federal estate tax, which is only owed on any value above the $11.7 million threshold, a Massachusetts estate is taxed on almost its entire value. An estate that’s worth just over $1 million could pay tens of thousands of dollars in estate taxes without proper planning. 

Gifting may affect your estate taxes. Gifts you make now may increase your estate’s tax bill later, so estate tax planning has to be part of the discussion before you make any significant gifts. Again, state estate tax laws come into play with gifting. In Massachusetts, any taxable gifts you make during your lifetime are added back into the value of your estate at the time of your death. Say your estate is worth $950,000 when you die, but you gave a $60,000 gift to help one of your kids make a down payment on a home. That gift puts your estate over the $1 million threshold and triggers the estate tax. 

Your estate tax plans may change as laws change. Like other elements of financial planning, estate tax planning isn’t a one-time process. The estate tax plans you created years ago won’t necessarily protect your assets if they reflect outdated laws. 

Updating those plans—or doing estate tax planning for the first time—becomes especially important whenever there’s an administration change. The federal estate tax exemption was doubled by the Tax Cuts and Jobs Act in 2017, and is set to drop back to a pre-TCJA exemption level of $5 million per person (to be adjusted for inflation) in 2026. During his campaign, President Biden proposed lowering the threshold even further, to just $3.5 million per person. The $1.8 billion American Families Plan his administration announced in April didn’t include any proposals directly related to the estate tax, but did outline a plan to change the step-up in basis rules. 

A change to the step-up in basis provision could have a significant effect on the way many people approach estate tax planning. Say you inherit a home from a parent. They paid $100,000 for the home in 1990 and it’s worth $3 million when you inherit it. With the step-up in basis provision in place, the value of the inherited asset is assessed when it’s transferred. If you sell the home a year later for $3.2 million, you would owe capital gains taxes on just the $200,000 increase that occurred while you owned the property. If the step-up in basis is repealed, your capital gains tax bill is assessed based on the original value of $100,000. The Biden administration’s proposal would allow for a $1 million exemption, but in this example you would still be taxed on a $2.1 million capital gain. 

The bottom line? As laws around estate taxes and asset transfers evolve, estate tax planning helps you stay ahead of any changes that could increase your own tax bill after an inheritance, and the tax bill that your estate incurs upon your death. 

What Estate Tax Planning Looks Like

How financial planners approach estate tax planning really depends on each client’s specific needs. When you meet with your tax planner and/or financial advisor, you might start by talking about your assets and what you plan to leave to whom. From there, advisors can help you evaluable your options and identify the estate planning tools that will best protect those assets. Trusts are commonly used as part of the estate tax planning process. 

Estate tax planning may also be urgently important if you expect to inherit any assets from an older loved one, and/or if you expect to administer a loved one’s estate in the future. If you know that a parent plans to leave their home to you, for example, meeting together with an advisor can help both parties prepare for what might happen during the asset transfer—and create the tax plans that help you maximize your inheritance. 

Sachetta Callahan’s team of financial advisors helps clients with every element of the estate tax planning process. Your financial plans aren’t complete unless you’ve considered how estate taxes might come into play. It’s a key part of protecting your family’s financial future, and we’re here to make it as easy as possible. How can estate tax planning help you prepare for what happens next? Contact me today!

Michael J Callahan, CPA, CFP®, MST, Partner, Director- Wealth Management Michael is a Certified Financial Planner™ practitioner, Certified Public Accountant, and holds a Master’s Degree in Taxation from Bentley University. Mike has been involved in personal financial planning, as well as both business and individual taxation for more than 15 years.

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