Year-End Estate Planning Update: Strategies for 2025

The 2025 transfer tax exemption will remain at a historically high level before being reduced by 50% on January 1, 2026 under current law. As it remains uncertain whether the new Congress will enact legislation to maintain the current exemption amount, taxpayers should continue planning with the current law in mind. There are a variety of strategies available to take advantage of current exemption levels.

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 $13.61 million per person in 2024 and will increase to an unprecedented $13.99 million in 2025. However, under current law these exemptions will be reduced by 50% on January 1, 2026 (but still inflation adjusted each year). While Congress may do nothing and maintain the current transfer tax laws (allowing the exemptions to be cut in half), or repeal the transfer taxes altogether, due to budgetary constraints, it is more likely that Congress will simply extend the timeframe for when the exemptions will be reduced, perhaps by two, four, or 10 years. 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 Illinois estate tax exemption remains at $4 million per person, as this exemption does not receive an annual inflationary increase.

For individuals concerned about estate taxation upon death, there are estate planning strategies available to utilize the current historically high exemptions. However, these strategies must also address the potential loss of a basis change on death. Estate taxes are imposed at a 40% federal rate on a decedent’s “taxable estate” not qualifying for a marital or charitable deduction, plus potential state estate taxes. In Illinois, the effective marginal tax rate ranges from 8% to approximately 29%. As with income taxes, state estate taxes are deductible for federal estate tax purposes, resulting in a cumulative federal and Illinois estate tax rate (for estates above both the federal and Illinois exemptions), taking deductions into account, of approximately 48%. The trade-off is the loss of the basis change at death (discussed below), which can result in an income tax cost on any “built in” gains aggregating 28.75% (a federal 20% capital gains tax, plus the 3.8% federal net investment income tax, plus state capital gains taxes of 4.95% in Illinois).

In 2025, a married couple can transfer up to $27.98 million free of federal transfer tax, but as discussed above, under current federal law, the estate/gift and GST tax exemptions are to be reduced by 50% in 2026. 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 $6.995 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 $13.99 million before 2026) will “lock in” the benefit of the extra exemption.

Lifetime Transfer Strategies

In addition to making such annual exclusion gifts, taxpayers should strongly consider lifetime gifting strategies in 2025 in excess of those amounts. Taxpayers who have not used the “extra” exemption before January 2026 may 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 transfers of assets with high potential for appreciation. For taxpayers who live in states with a state estate tax but no state gift tax (such as Illinois), lifetime gifting will also have the effect of reducing the state estate tax liability.

New Rules for Required Minimum Distributions from Certain Inherited IRAs

The IRS issued new Final Regulations in 2024 that Required Minimum Distributions from certain retirement plans that beneficiaries must take to avoid penalties (hereinafter referred to as “inherited IRAs” even though they encompass all retirement plans). Congress enacted the SECURE Act in 2019, which set the current law for Required Minimum Distributions from inherited IRAs and other retirement plans. In general, other than a spouse, minor child of the decedent, or disabled child of the decedent for whom special “stretch rules” may apply, beneficiaries have a 10-year period within which all of the IRA funds have to be withdrawn to avoid penalties (no distributions until December 31 of the year in which the 10th anniversary of death falls). Based upon this rule, many beneficiaries intentionally planned to not withdraw IRA funds until the end of the 10-year period in order to let the funds grow income tax deferred (unless earlier distributions could be made at a lower income tax rate based upon their individual situation year by year). Effective for taxable years beginning on or after January 1, 2025, the IRS’s new Regulations change this 10-year rule for beneficiaries that inherited an IRA from a decedent that was passed his or her “required beginning date” (age 72 if the decedent was born in 1950 or before, age 73 if born 1951-1959, and age 75 if born 1960 or later). For such beneficiaries (the decedent dying past his or her required beginning date), the beneficiary is required to take annual distributions during the 10-year period based upon the beneficiary’s life expectancy and must drain whatever is left by December 31 of the 10th year after death. Failure to take the Required Minimum Distribution can result in significant penalties. This annual Required Minimum Distribution amount does not apply to spousal rollover IRAs, to IRAs for which the beneficiary qualified and was using a special life expectancy rule, to IRAs when the participant died before his or her required beginning date, or to IRAs inherited before 2020.

Planning for Basis Change

Good estate planning incorporates income tax and other considerations rather than focusing myopically on estate, gift, 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 trade-off 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

As of January 1, 2024, domestic and foreign entities created by filing with a Secretary of State or foreign entities registered to do business with a Secretary of State (i.e., corporations, LLCs, and limited partnerships), are required to report beneficial ownership information to the Financial Crimes Enforcement Network, subject to limited exemptions. “Reporting Companies” are 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.

Entities in existence before January 1, 2024 have until December 31, 2024 to comply with the reporting requirement. Entities formed in 2024 have 90 days from the date of formation to comply with the reporting requirement. New entities formed on or after January 1, 2025 will have 30 days from formation to comply with the reporting requirement. There is also a supplemental filing requirement every time any information on the filed Report changes, due 30 days after each such change.