Estate Planning: Gifting Strategies through 2025

On December 31^st 2017, the Tax Cuts and Jobs Act (TCJA) doubled the federal lifetime gift and estate tax exemption from around $5.5M to about $11M. This higher exemption amount has continued to increase indexed for inflation and the exemption in 2021 is $11.7M. After 2025, the TCJA is set to ‘sunset’ and the exemption reverts to pre-2018 levels, adjusted for inflation, for an estimated future exemption amount of $6.8M.

In this insight, I’ll explain what the TCJA means for estate and gift taxes and discuss some possible planning and gifting strategies moving forward.

Estate Tax Exemption

Generally speaking, estates valued at death under $11.7M (as of 2021), will not be taxed at the federal level. For example:

• If an individual passes away in 2021 with assets valued at $10M – their taxable estate will be $0, and there will be no federal estate taxes due.
• As the rules are today, if that same individual passes away in 2026 with assets valued at $10M – they will have a taxable estate of $3.2M ($10M minus $6.8M).

Gift Tax Exemption

On an annual basis, individuals have an annual gift-tax exclusion amount of $15K (as of 2020) per donor, per donee. This means an individual can gift up to $15K to another individual with no federal gift-tax consequences and no required reporting. Any amount over the annual gift exclusion amount is considered a “taxable gift.”

How Estate and Gift Taxes Work Together

The $11.7M exemption (as of 2021) applies to gifts and estate taxes combined – whatever exemption you use for gifting will reduce the amount you can use for the estate tax. For example:

• An individual passes away in 2021 with assets valued at $10M, but also made $2M of taxable gifts during life. The $11.7M exemption is absorbed by the combined $10M assets and $2M of taxable gifts and results in a taxable estate of $300K.
• An individual made $9M of taxable gifts in 2020 and passes away in 2021 with assets valued at $1M. the combination of taxable gifts and assets at death is less than the $11.7M exemption. Therefore, the taxable estate will be $0 and there will be no federal estate taxes due.
• What if an individual made $9M of taxable gifts, trying to take advantage of the current higher gift exemption limit, but still has assets valued at $1M at death in 2026 when the exemption amounts step back down to pre-2018 levels?
  
  

The answer to the last question was unclear, causing concern for taxpayers until late in 2019 when the IRS confirmed the allowance of an estate to compute its estate tax credit using the higher of the exemption amount applicable to gifts made during the life, or the amount applicable on the date of death.

Let’s look at a few examples to see the impact of this good news to high-net-worth individuals:

• An individual passes away in 2026, made no lifetime taxable gifts, and has assets worth $13M. Their taxable estate is $6.2M ($13M minus $6.8M, the new stepped-down exemption).
• An individual passes away in 2026 but made $4M of taxable gifts prior to 2026 and had remaining assets worth $9M. Because the amount of gift-tax exemption used prior to 2026 is less than the stepped down exemption amount, the credit applied to compute the estate liability is based on the $6.8M exemption. They used $4M during their life so they have $2.8M remaining. Their taxable estate is $6.2M ($9M minus $2.8M, the remaining exemption). There is only a benefit from making additional taxable gifts before 2026, if the total lifetime gifts exceed the stepped down exemption. The taxable estate is the same as if this individual used zero of the gift-tax exemption as shown in the first example.
• That same individual passes away in 2026 but made $9M of taxable gifts prior to 2026, and now had remaining assets worth $4M. According to the regulations, the credit applied to compute the estate liability is based on a $9M exemption, the exemption amount absorbed when the higher limit was in place, instead of the new stepped down $6.8M exemption. There is now a taxable estate of $4M, instead of $6.2M.
• That same individual passes away in 2026 but made $11M of taxable gifts prior to 2026, and now has assets worth $2M. The credit applied to compute the estate liability is based on a $11M exemption, the exemption amount absorbed when the higher limit was in place, instead of the new stepped down $6.8M exemption. There is now a taxable estate of $2M.
  
  

Although the assets gifted during life and the assets left in the estate totaled $13M in all of the examples above, the taxable estate decreases dramatically by taking advantage of the higher gift exemption limit in the years 2018-2025. Reducing the amount of the taxable estate can provide substantial tax savings. Estate and gift tax rates are 40% federal and many states impose an additional tax. 

Are Gifting Strategies a Good Fit For You?

Estate planning strategies must be evaluated in the context of real-life circumstances and needs. There could be large tax savings if these gifting strategies are implemented; but of course, there could be negative implications to gifting assets away – such as loss of control and the ability to use the assets to supplement lifestyle. Gifted assets also lose the “step-up” in basis at one’s passing. These strategies can also be used in combination with other estate planning approaches to take advantage of our historically low interest rates. And finally, it’s also important to note that with the recent change to the Biden administration, there could be less time to implement these strategies than assumed above if there are legislative changes. Before implementing the strategies above, make sure to consult with your estate attorney and financial advisor.

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