Estate Planning After 2026

Beginning in 2026, the federal estate, gift and generation-skipping transfer tax exemption (federal exemption) permanently rises to $15 million per person ($30 million for married persons) and will be indexed for inflation. Accordingly, if a taxable estate is equal to or less than the federal exemption, the estate will owe no estate tax. However, if the taxable estate exceeds the federal exemption, such excess will be taxed at 40%. For example, if a taxable estate is $16 million, the estate would owe $400,000 in federal estate taxes (approximately 2.5% of the taxable estate).

Because the federal exemption is ele­vated, in the future, only a small number of estates will be required to file a federal estate tax return. In fact, in 2024, when the federal exemption was $13,610,000, it is estimated that only 0.25% of estates filed a federal estate tax return.

Avoiding Double Taxation

In addition to being subject to estate taxes, assets owned at death are also subject to income taxes. To ameliorate the burden of this double taxation, the law allows the income tax basis of certain assets received at death to adjust to their date-of-death fair market value (FMV). Thus, if a taxpayer’s aunt bequeathed him 200 shares of Apple stock that she bought for $20,000 ($100 per share) and which had a FMV of $54,000 ($270 per share) on her date of death, that taxpayer’s income tax basis for these shares would be “stepped-up” to $54,000. As a result of this “step-up” in basis, if the taxpayer sold these shares two months later for $60,000 ($300 per share), he would only recognize a long-term capital gain of $6,000 (200 shares x $30 per share of post-death appreciation) versus recognizing a long-term capital gain of $40,000 (200 shares x $200 per share of total appreciation). However, if the FMV of the Apple shares on the aunt’s date of death were $18,000, then the taxpayer’s income tax basis would be “stepped down” from $20,000 to $18,000.

Since both the securities and real estate markets have been good over the last 15 years, the income tax basis of assets received at death have been mostly “stepped-up” and not “stepped down.”

Unfortunately, not all assets received at death are subject to this income tax adjustment. The income tax basis of “Income in Respect of a Decedent” (IRD) assets do not get adjusted to their date-of-death FMV. IRD assets include, but are not limited to, IRAs, 401(k)s, 403(b)s, 457s, qualified annuities, installment notes and uncollected compensation.

In 2024, when the federal exemption was $13,610,000, approximately 0.25% of estates filed a federal estate tax return. For the 99.75% of estates that were not — and in the future will not be — subject to the federal estate tax, qualifying for the “step-up” in basis to eliminate the income tax on the lifetime appreciation of such assets will become the focal point of most estate planning. For an asset of the decedent to qualify for a “step-up” in basis, such asset must be included in the decedent’s estate. Accordingly, including (rather than excluding) an asset in the decedent’s estate for federal estate tax purposes will become the norm for most estate planning.

Finally, because the federal exemption is high, more attention will be paid to the minimization of state and inheritance taxes.

The permanent rise in the federal exemption will significantly alter the future principal focus of estate planning from minimizing estate taxes (by keeping assets out of the decedent’s estate) to minimizing income taxes on appreciated assets included in the decedent’s estate and minimizing state and inheritance taxes on assets received at death. It will remain important to ensure that a deceased spouse’s unused federal exemption will be available to the surviving spouse (i.e., portability) to minimize federal estate taxes.