Estate and Gift Tax Lifetime Exclusion Amount
The Tax Cuts and Jobs Act (TCJA, often referred to as tax reform) generally went into effect in 2018. Tax Reform increased the federal estate and gift tax lifetime exclusion amount (LEA) from $5 million per person to $10 million per person. On top of that, there is an annual adjuments to the exclusion for inflation, meaning the inflaction-adjustment for LEA in 2020 is now $11.58 million.
Federal Estate Tax Provisions
However, the provisions of TCJA are temporary, and unless Congress makes changes, the exclusion will revert to the pre-TCJA amount of $5 million (an estimate to be $6.2 million upon the inflation adjustment) beginning in 2026. However, the elections in November, which will depend on which party comes out on top, could change all that. Why could it all change due to November’s election and whether or not a Republican or Democrat wins the Presidency? The current Democratic candidates propose to reduce the Lifetime Exclusion Amount, with $3.5 million. At least, they seem to mention the amount of $3.5 million most often.
Estate and Gift Tax Concerns Regarding Large Gifts
Recently, there has also been concern among financial experts and estate attorneys. These concerns are in relation to what will happen. For example, what about large gifts that are made while the LEA is at the higher lifetime exclusion amount? What happens if the exclusion amount reverts to the pre-TCJA amount? Would those larger gifts become taxable in excess of the lower LEA?
For Example: In 2020, Joe makes a gift of $8 million to his son. Since the LEA is $11.58 million, Joe would not incur any gift tax liability in 2020; but what will happen in 2026 when the LEA drops back to $5 million (adjusted for inflation)?
Will the difference between the $8 million gift made in 2020 and the lower LEA in 2026 trigger a gift tax?
What will the impact be for Joe’s estate tax exemption should Joe die after 2025? Meaning, generally the amount of his LEA that hasn’t been used to offset taxable gifts during his lifetime?
Special IRS Rule to Compute Estate Tax
Luckily, the final regulations issued by the IRS provide a special rule. That special rule allows an estate to compute its estate tax using the higher of the LEA. Also, it is applicable to gifts given during life or the LEA applicable on the date of death. Thus, making large estate gifts now won’t harm estates after 2025, something wealthier taxpayers should take into their planning considerations.
Gifting While the LEA Is at Its Current Level
So, it may be appropriate for those with larger estates to consider taking advantage of the current larger LEA. Meaning, make larger gifts before the LEA reverts to lower levels or Congress changes it to a lower amount. Of course, when considering such gifts, one would need to be sure the remaining estate would sustain one’s current lifestyle adequately without undue risk. It is also important that the gifted assets, if not cash, will hold their value. This means, gifting assets do not use up LEA that might end up decreasing in value.
Another consideration in gifting assets is that the gift recipient, AKA Donee in tax lingo, assumes the tax basis of the donor. Therefore, the gift essentially passes to the Donee with any tax liability of the donor. This is so, even though the current gift amount is the current fair market value of the asset.
Annual Gift Tax Exclusion
Or, the Annual Gift Tax Exception. Gifting reduces an estate and is the reason there is a gift tax. Basically, preventing estates from being gifted away prior to death and depriving the government of estate taxes. In addition to the LEA, there is an annual gift tax exclusion that allows a donor to gift up to as much as $15,000 (inflation adjusted amount for 2020) per year to as many recipients (relative or not) as they would like.
For example, a parent with four children could give each of them $15,000 without any gift tax ramification. A married couple could give each child $30,000 per year. If the children were married, the parents could gift the couple up to $60,000 per year. In addition to the $15,000 annual exclusion, there are two situations in which gifts don’t count toward the annual exclusion amount: when a donor makes payments directly to an educational institution for the tuition of a donee (does not include other education expenses) or payments are made directly to any person or entity providing medical care for the donee.
Another current aspect of estate planning is that inherited assets have their tax basis adjusted to the fair market value of the asset at the time of the decedent’s death. This is “step up in basis.” As a result, estate beneficiaries will incur little or no taxable profit if the inherited property is immediately sold. However, a number of presidential candidates are proposing to do away with “step up in basis,” adding another variable to the long-term estate planning issues.
Capital Gains Rates
Currently, upon inheritance, the treatment of assets are immediately held long-term. And, the benefit from the special lower tax rates are for long-term capital gains. Virtually all of the Democratic candidates made the indication that they would like to see the special long-term capital gains rates go away. And, Democrates would like to see all gains subject to the ordinary tax rates that apply to other types of income, such as wages.
All these possible variations, make it very difficult to develop estate plans with any long-term certainty. These include a probable substantial change in the LEA in the future. Also, the possible elimination of “step up in basis” for inherited assets, and potential abolishment of capital gains rates.
Those with substantial estates should follow future developments and adjust their estate planning accordingly. If you have questions related to estate tax issues, please give Alex Franch, BS EA at 781-849-7200. We have locations in Norwell, Dedham and South Weymouth, Massachusetts.