Inflation fuels sharp rise in prized tax break for the wealthy

Inflation could end up saving the ultra-wealthy next year nearly $700,000 on the tax that's imposed on their assets when they die.

The estate tax, like many other federal taxes, is indexed to consumer costs — and, because of soaring prices, the IRS says the point at which people have to begin paying the 40 percent levy next year will jump by an eye-popping $1.72 million per couple.

The hike is coming as a major reduction in the estate tax pushed through by the Trump administration is slated to expire in the next few years. Unless lawmakers act, the amount people can exempt from the levy will suddenly fall by more than half beginning in 2026.

The inflation adjustment, which would bring the total amount couples can shield from the tax to $25.8 million, is surprising some wealth advisers who not that long ago had been bracing for Democrats to raise taxes on the rich at death.

“It’s the largest increase we’ve seen in my lifetime,” said Belinda Herzig, senior wealth strategist at BNY Mellon Wealth Management. “I’m very busy.”

People don’t necessarily have to die in order to benefit.

They can transfer money and other assets to children and other people tax-free while the giver is still alive in order to reduce their exposure to the estate tax when they die.

The adjustment is part of a host of changes to taxes and Social Security benefits triggered by rising prices. Many automatically increase with consumer costs so that taxes and benefits stay roughly constant in inflation-adjusted dollars.

The increases, dictated by long-standing provisions in the law and set by arcane formulas, come without lawmakers doing anything.

The IRS has announced more than 60 inflation adjustments to the tax code, including boosts in everything from how much people can put in 401(k) retirement accounts to the earnings thresholds at which different tax brackets take effect to how big an “expatriation tax” people must pay when they renounce their American citizenship.

Most provisions will see a 7 percent increase, which for millions of people will translate into bumps in their paychecks as employers withhold less in tax.

Some of the individual changes are modest because the 7 percent increase is keyed off a small number. A tax break for commuters using public transit, for example, will grow by $20 per month to $300.

But the current estate tax exemption is $12.06 million per person, so a 7 percent hike — $860,000 — is much bigger in that case. Married couples can use each other’s exemptions, and next year’s combined $1.72 million increase in the exclusion is larger than the entire estate tax exemption that was in place when George W. Bush became president.

The tax is paid by a tiny share of people — only about 2,600 taxpayers owe the levy, IRS figures show. Three-fifths of the $18 billion it raises is paid by estates worth more than $50 million.

The inflation increase comes despite a concerted though unsuccessful push by Democrats to hike taxes on the rich when they die. Arguing the wealthy were not paying their fair share, Democrats not only wanted to raise the estate tax, they pushed to eliminate related tax provisions that allow high-net-worth people to sidestep capital gains tax bills on assets they leave to heirs.

Democrats will get another crack at the estate tax in the runup to 2026, when much of Republicans’ 2017 tax overhaul will expire. Republicans are pushing to extend the provisions.

In the meantime, estate tax advisers say they are urging clients to act now to make use of the extra-large exemption — by giving money to children, for example.

The IRS’s new inflation adjustments will allow people next year to give away, tax-free, up to $17,000 per person annually, without affecting their estate tax exclusion. That’s up $1,000 from this year. Gifts beyond that would reduce their exemption.

So a couple with two children and five grandchildren can give them next year $238,000 annually without eating into their estate tax allowance.

People are also free to give away the entire $25.8 million that's now exempt from the estate tax while they’re still alive.

Those sorts of gifts are common now among high-net-worth families — and not just because of the looming expiration of Republicans’ cut to the levy, said Brad Roe, an estate tax adviser at Grant Thornton.

Prices for stocks and many other assets have been beaten down over the past year by the Federal Reserve as it raises interest rates in hopes of quashing inflation. That can be advantageous to those concerned about the estate tax because those depressed values mean they can give away more without bumping into the estate tax limits.

And that’s particularly valuable if the price of those stocks, for example, is likely to rebound later, after they’ve been given away, Roe said.

“The stock market has not done very well, and depending on the type of asset you’re transferring, you could transfer a lot more than you could this time last year,” he said. “We have a window of opportunity here.”

“There’s a saying in estate tax planning that you’re going to give your property to your family, to charity or to the Internal Revenue Service,” Roe added.