Lock In Lifetime Gift & Estate Tax Exemption

The year 2020 has been full of uncertainty. The area of taxation is no exception.

Under current law, the lifetime exemption for gift, estate, and generation-skipping tax is $11,580,000 per person. The exemption is adjusted annually for inflation but is set to expire at the end of 2025. For years after 2025, the exemption returns to $5 million with inflation adjustments in future years (estimated to be approximately $6.5 million in 2026). President-elect Biden’s tax proposal calls for a reduction in the exemption amount, as well as other changes to estate tax laws. At this point, it is simply a proposal. There is nothing certain about if, or when, changes may occur – except we do know the current levels expire at the end of 2025.

If you are concerned about possible reductions in the lifetime gift and estate exemption or want to take full advantage of the current level of exemption, you might consider a gifting strategy before year-end.

When the exclusion amount was increased under the Tax Cuts and Jobs Act (TCJA) of 2017, one of the most pressing concerns was the consequence of making large lifetime gifts under the increased exclusion amount with death occurring after the exclusion reverted to the lower levels in 2026. This concern has commonly been referred to as the “clawback” question. The IRS has now provided guidance regarding this concern.

The final regulations make it clear there is no clawback. The anti-clawback rules ensure that when a lifetime gift is made using the increased exclusion amount, and then one dies after the increased exclusion sunsets in 2025, the decedent’s estate will not claw back the excess. Under current law, making a lifetime gift utilizing the increased exclusion limit will lock in the benefit of the higher exemption.

What about using up a partial exclusion amount?

If gifts during life are less than the exclusion in effect at death, there is no benefit from the increased exclusion amount. For example, if a donor makes a gift in 2020 of $5 million and dies after 2025 when the exclusion has reverted to $5 million (adjusted for inflation) the exclusion has been used. There is not a carryover of the unused portion from the year 2020 to future years. If that gift was more than the exclusion available at death, there would be a partial benefit. For example, if an individual makes a gift of $7 million in 2020 and dies after 2025 when the exclusion has reverted to $5 million (adjusted for inflation) the donor receives the benefit of the full exclusion of $7 million, but not the full $11.58 million (adjusted for inflation).

The increased exclusion amount is a “use it or lose it” benefit, and is available to a decedent who survives the increased exclusion period only to the extent the decedent used it by making a lifetime gift. There is one exception, and the exception involves married couples. If one spouse dies before 2026 and the surviving spouse elects to preserve the deceased spouse’s unused exclusion, the preserved exclusion may be used by the surviving spouse’s estate, along with the survivor’s available exclusion.

The type of assets gifted should be considered when weighing this decision. Under current law, appreciated capital assets transferred at death receive a step-up in basis to fair market value at date of death. Whereas, appreciated assets transferred by gift during life retain the original basis in the hands of the donor when transferred to the donee (carryover basis).

If you are considering gifting interests in family limited partnerships or closely-held businesses you may need a valuation report to document the value of the interest being transferred. You are required to attach a valuation meeting certain guidelines if any discounts are claimed for minority interests or limited marketability. We have a team of individuals who can provide this documentation. Contact us if you’d like to learn more.

There are many factors to consider when deciding whether or not to make gifts. If your family has significant wealth to transfer to the next generation, you might consider making gifts while the lifetime exclusion amount is higher. The 2025 sunset under current law may seem far off, but planning now could result in significant wealth transfer tax savings.

As we said at the beginning, tax laws change and there is no guarantee the higher exemption amount will remain in place through 2025. It is important to consult with your advisors to determine the best approach for your situation.

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