How to Lock In a $14M Estate Tax Exemption Before 2026

If business owners and other high-net-worth individuals do not act this year, they could miss out on significant planning opportunities that could otherwise assist in the tax-free transfer of millions of dollars within their family's estate. Multiple planning steps are required to maximize the current estate tax exemption, which is scheduled to be cut in half at the end of 2025.

The estate tax exemption for 2024 is $13.61 million per person or $27.22 million for couples. The exemption — officially the basic exclusion amount — is indexed to inflation, so it will rise again next year before it gets cut in half at the start of 2026. The result is a loss of roughly $7 million of exemption for each person.

The upcoming change is part of the 2017 tax overhaul, which both doubled the existing exemption and scheduled it to sunset without additional action by Congress. In practical terms, couples could leave far more than $14 million on the table if they don't act ahead of the sunset, using strategies to ensure that the growth of that money after 2025 is also estate-tax free.

Tax-Saving Estate Strategies

One of the best strategies is to create two irrevocable trusts, such as a dynasty trust or a spousal lifetime access trust, and make gifts to the trusts to lock in the current estate tax exemption.

Couples could consider structuring the first trust as a spousal lifetime access trust with the spouse as the beneficiary and the second as a dynasty trust with the children as the beneficiaries. However, couples often prefer to have multiple spousal lifetime access trusts so that one spouse is not left out as a non-trust beneficiary.

In creating multiple spousal lifetime access trusts with spouses as beneficiaries, they must not be so interrelated as to trigger the reciprocal trust doctrine, which the U.S. Supreme Court first examined in United States v. Estate of Grace in 1969. This doctrine prevents spouses from creating, for example, two trusts on the same date with the same terms, except with alternating spouses as creator and beneficiary.

There are a variety of factors that the Internal Revenue Service and courts consider in determining whether trusts run afoul of the reciprocal trust doctrine and thus lose their tax advantages by causing both trusts to be included in the estates of each spouse.

Timing is one of the most important elements of the doctrine: The more separation between the creation of the two trusts, the better, because they are not interrelated. That is why it is important to create the first trust as soon as possible this year and then create a second, if desired, at a later time.

Another element of the reciprocal trust doctrine involves differing terms and powers within the trust, such as whether one beneficiary spouse has a lifetime special power of appointment while the beneficiary spouse in the other trust does not.

In a 1983 Tax Court case, Estate of Levy v. Commissioner, the two trusts were nearly identical with the same beneficiaries and asset funding on the same date, but one trust granted a lifetime special power of appointment for the spouse, and the other did not. The court ultimately ruled that the reciprocal trust doctrine did not apply.

Additional elements of the doctrine include whether the trusts have the same trustees, secondary beneficiaries and distribution standards. For example, one could use the health, education, maintenance and support standard, which allows the spouse to be both the trustee and the beneficiary. The other could require the trustee to be independent of the family (having different trustees and distribution standards go hand in hand).

Finally, whether the trusts have different assets is another element of the reciprocal trust doctrine. For example, one spouse could give real estate, cash and securities to one trust, while the other spouse could give their business interest to the other trust. The exact assets at play are not as important as the fact that each spouse gives something different. Arranging asset ownership in an effective manner can require additional time.

In conclusion, families with assets in excess of $14 million should take initial steps this year to lock in the estate tax exemption under the 2017 tax overhaul. They have a range of options — and limitations under the reciprocal trust doctrine — to consider. Partnering with an experienced estate planning attorney can be helpful as they sort through the best strategies.

Jeff Morris, a partner at Parker Poe in Charlotte, North Carolina, is a North Carolina State Bar board-certified specialist in estate planning and probate law.