Until now, many have enjoyed knowing their beneficiaries could inherit their assets tax-free through an irrevocable trust. It has been used successfully to pass assets safely to children without tax. For many people, it will no longer accomplish that goal and a life insurance policy may be the only way.
The New Rule on Irrevocable Trusts
In March 2023, the Internal Revenue Service (IRS) changed the usefulness of an irrevocable trust for many people in theirRevenue Ruling 2023-2. The ruling will eliminate the benefit of having this kind of trust unless set up correctly.
The new document eliminates the possibility of avoiding capital gains tax by placing assets into an irrevocable trust. A growing number of Americans relied on this estate-planning tool to quickly pass their assets to their children and preserve their estate with minimum taxes.
Others used irrevocable trusts to escape having to spend down their assets so they could qualify for Medicaid. Medicaid requires that people wanting assistance for long-term care spend down their assets before qualifying. Some people managed to turn some of their money into paying for medical costs,MSNsays, and medical home improvements, including a chair lift.
People with a lot of assets would often set up an irrevocable trust to remove the assets from the possession of the grantor. At the same time, it placed them under the trust’s control—enabling them to be passed to the beneficiaries tax-free.
When the beneficiaries receive the assets, the assets receive a stepped-up value. It means they are given the fair market value when the grantor died instead of at the time of purchase. It enables the beneficiary to avoid paying capital gains taxes on the assets unless they are sold later and have become higher in value.
In the new Revenue Ruling, the IRS says that assets in an irrevocable trust are technically not part of the estate, and, therefore, estate taxes need to be paid. They claim now that the assets need to be under the direction of a will. The goal, it appears, is to be able to collect a lot more taxes on estates.
Giving Gifts to Reduce Your Taxable Estate
One of the best ways to reduce your estate and not have to pay taxes is to give it away. Right now, you can give away more money than ever, but only up to Dec. 31, 2025. The gift and estate exemption allows you to give away up to $12.92 million. A couple can give away up to $25.84 million. After 2025, this exemption decreases to $5.49 million, which is where it was up until 2017.
Giving monetary gifts to your loved ones enables the money to escape estate taxes and reduces your estate at the same time. The sooner you give it to your children, the more interest it gains, the more it grows. If you do not give it away, your estate could be taxed up to 40 percent.
Right now,Schwabsays you can give up to $17,000 to as many people as you want. The recipient will not owe any taxes and does not need to report it. Gifts of more than $17,000 must be reported on Form 709. Couples always need to use Form 709. Gifts of more than $17,000 reduces your lifetime gift and estate tax exemption.
Some Estates Do Not Require Filing
TheIRSsays that simple estates do not require you to file estate taxes. A simple estate involves cash, some assets that can be easily valued, publicly traded securities, property that is jointly held, and not having any special deductions or elections.
You must file taxes if the gross estate—the total fair market value of everything you own—is worth more than the exemption. It includes cash, securities, insurance, annuities, real estate, business interests, and any other assets.
Because the estate tax exemption is so high, it is doubtful that most families will ever need to pay an estate tax. It will only be necessary if you have an estate worth more than $12.92 million. The exemption will reduce to about half in 2026.
When the assets of the deceased are worth more than $12.92 million, a federal estate tax return must be filed. No federal tax is due if the estate passes to the surviving spouse. If an estate is more valuable than $12.92 million, taxes will be due on amounts higher than the exclusion, and those rates range from 18–40 percent.
Inheritance Taxes
The federal government does not have an inheritance tax. Most states do not have one, but six states do: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. The tax in those states will vary, and rules about the tax will also differ.
Closer relatives can expect to pay fewer taxes. Spouses or domestic partners do not pay inheritance taxes in any of the six states. Descendants will only pay an inheritance tax in Nebraska and Pennsylvania.
Some states also have an estate tax, but only Maryland has an estate tax and an inheritance tax. Property owned in other states by the deceased may require estate and/or inheritance taxes.
Avoiding Taxes When Transferring Assets at Death
In addition to gifting money to your children and others, you can avoid estate taxes by consulting with an experienced licensed advisor taking out a life insurance policy for the amount you want to pass on. Life insurance policies will not require any taxes. Unless you want the beneficiary to have the money sooner by giving monetary gifts of up to $17,000 per year which for some may be a better choice. But for most the life insurance policy is the most practical and reasonable.
The IRS document does not completely negate the value of irrevocable trusts—it simply means that the wording of the legal documents must be precise. The trust and its assets must be in the taxable estate. If you have an irrevocable trust or are thinking of creating one, talk to a trust attorney familiar with estate planning and elder law.
