Potential Changes to the Lifetime Exclusion & Estate Planning Considerations
Living life inside the confines of a pandemic has given many of us cause to reevaluate our priorities and our personal and financial goals. For some taxpayers, that process has reshaped the plan for the legacy they wish to leave, altering the nature and extent of the estate planning considerations involved in determining an optimal strategy. The current federal lifetime exemption amount for gift and estate tax is higher than it has ever been over its century of history. If, as you reevaluate your circumstances, you find that your finances permit, you may want to consider gifting large amounts to your loved ones in the near future.
While the exemption and exclusion amounts have been on a steady upswing in the past, this particular piece of history is not likely to repeat itself.
The version of federal estate tax we know today, including the lifetime exclusion, came about in 1916, and federal gift tax followed shortly after in 1924. While gift and estate tax laws as we know them were initially enacted around the time of the influenza pandemic, ironically, many donors and beneficiaries will see the greatest benefits from related tax laws amid today’s coronavirus pandemic.
The current unified lifetime gift and estate tax exemption is $11.7 million, which means individuals can make tax-free gifts of up to $11.7 million over their lifetime or upon their death. For married couples, the exemption doubles to $23.4 million. The increased exemption, which is adjusted for inflation each year, will remain in place until the TCJA provision sunsets after 2025. Currently, amounts over the exemption are taxed at a 40% rate. The annual gift tax exclusion is $15,000 per donor, per recipient. Gifts meeting the annual gift tax exclusion requirements do not create a gift tax liability for the donor or recipient, nor do they affect the donor’s lifetime exemption.
The impending sunset of the TCJA provision in 2026 isn’t the only threat to the increased exemption amount. President Biden’s tax plan proposes a reversion to amounts we have not seen since 2009 when the estate tax exemption was $3.5 million and the lifetime gift tax exclusion was $1 million. The plan also proposes a 5% increase in the top tax rate, increasing it to 45%. The Biden Administration has also proposed tax law changes that would affect the savings currently provided by Grantor Retained Annuity Trusts. The exact timeline for these changes is uncertain; however, the plan proposes these changes go into effect retroactively to January 2021.
Depending on the value of your estate, you could save millions in estate tax by gifting large amounts now.
Let’s say an individual’s estate is worth $15 million, and they give $11.7 million in gifts over their lifetime and ahead of any reduction to the exemption amount. If that individual passes away in 2021, the $3.3 that is over their lifetime exemption would be taxed at a rate of 40%, and the estate tax liability $1.3 million. Should Biden’s proposed plan go through, $11.5 million of that same estate would be above the $3.5 million exemption and subject to a 45% tax. The resulting tax bill would be $5.2 million, which is a difference of nearly $4 million!
Because the estate tax could still be a significant factor if the exemption goes down, taxpayers with estates valued under the exemption amount should still consider gifting large amounts now. For instance, if an individual with an $8 million estate makes gifts totaling $3 million over their lifetime and ahead of a reduction to the exemption, those gifts will be tax-free. However, if the exemption is reduced to $3.5 million, $4.5 million would be over the exemption amount. And at an increased tax rate of 45%, the estate’s tax liability would be just over $2 million.
There are also alternate ways for donors and recipients to benefit from gifting that don’t involve handing over large lump sums. For example, donors may set up trusts, including 529 education trusts, spousal lifetime access trusts (SLATs), or generation-skipping trusts (GSTs). And there is no limit on tax-free gifts made to cover qualifying tuition and medical expenses when payments are made directly to the institution on a recipient’s behalf.
Moving assets out of your estate by gifting now could help you eliminate state-levied estate taxes typically assessed at death. In New England, New Hampshire is the only state that doesn’t levy its own estate tax.
Proposed changes to capital gains tax could increase taxes on your estate and for your beneficiaries.
Current law includes a provision known as a “step-up in basis” for assets transferred at death. For example, suppose you purchased shares of stock for $10 each in 2018 and held them in a taxable account where their value increased to $100 each by the time of your death in 2021. In that case, a beneficiary could sell a share at market value ($100) without paying any federal capital gains tax. If, on the other hand, you gift the same shares to that person before your death, the recipient would be subject to capital gains tax on the appreciation.
Biden’s plan would repeal the “step-up” of income tax basis for property that transfers at death and raise the top capital gains tax rate to 39.6%. And, combined with a reduced $1 million lifetime gift tax exemption, this could have significant tax consequences for your beneficiaries. For example, if you leave a home you purchased for $300,000 that’s now valued at $1.8 million to your child, the estate may not be able to cover the capital gains tax assessed on the gain minus the basis and exclusion ($1.5 million – $300,000 – $1 million = $500,000). If the tax liability is too high, your child could be forced to sell the home.
LGA’s Individual Tax Team is dedicated to helping clients create tax-efficient estate plans that meet their goals and needs. If you’re ready to reevaluate or create your estate plan and gifting strategy for 2021, contact me today.
Marci Cohen is a Partner at LGA. She has over 30 years of experience in providing individual and entity tax planning and compliance services. Marci’s focus is on high-net-worth individuals and families with complex reporting and planning needs, as well as their associated trusts, estates, and entities. With her collaborative and diligent tax planning approach, Marci ensures that her clients can achieve their personal financial goals.