Changes are likely brewing when it comes to estate and gift tax exemption amounts, which could mean a significant reduction in how much wealthy families can transfer to rising generations without taking a tax hit.
Currently, the federal estate, gift, and generation-skipping transfer (GST) tax exemption amounts are set at $11.58 million per individual, or $23.16 million for married couples. That means that federal tax is not owed on the transfer of assets below those thresholds. Importantly, those exemption amounts are currently set to increase annually through 2025. On January 1, 2026, absent a change in law, the exemptions will revert to $5.6 million, indexed for inflation from 2018.
However, these are no ordinary times.
The coronavirus pandemic and resulting economic crisis has triggered trillions of dollars of government stimulus spending, which will have to be paid for eventually. Simultaneously, the severe economic contraction has resulted in federal and state budgets being slashed. Many assume that taxes will have to increase to help pay for the massive stimulus measures and shore up government coffers.
The bottom line is that the current estate and gift tax exemption amounts may very well be on the chopping block, and well before 2026.
Depending on the results of the election this November, significantly lower estate and gift tax exemption amounts could be enacted as soon as next year, potentially even being implemented retroactively as of January 1, 2021.
While that is only speculation at this point, families with significant wealth should explore utilizing their exemptions now, as this could soon become a “use-it-or-lose-it” scenario.
Although some people may want to wait until after the November elections to make a decision, we recommend thinking through your options and even getting documents ready now. It would not be surprising to see a crush of people rushing to create trusts after the election, and financial institutions may have difficulty opening new trust accounts during the last eight weeks of the year.
So what should a family do at this point to prepare? Start by exploring your options as to how, and how much, to give.
How to give
Gifts can be made outright or to a trust for the benefit of descendants or a spouse. If a family already has irrevocable trusts in place, it may be possible to use those trusts to reduce the time and expense involved in making a transfer. Work with your advisors to determine the most advantageous way to structure gifts for your family.
How much to give
As stated above, the estate and gift tax exemption could become a “use-it-or-lose-it” scenario sooner than otherwise anticipated. If the exemption amounts are reduced, any gifts made in the past will count against the new lower exemption amount.
Therefore, if a married couple can afford to use both spouses’ remaining gift tax exemption (a total of $23.16 million, less any exemption allocated to previous transfers), they should. If the couple can’t, or is not comfortable using both exemptions, it is more tax efficient to have one spouse use the exemption in full, with the other giving what he/she can rather than making gifts in equal amounts. Because “splitting gifts” is a fairly common way to give, we also recommend reviewing 2019 gifts if that return hasn’t been filed yet, as part of this analysis.
What to give
All things being equal, it is best to gift assets with the greatest likelihood of appreciation, as all future appreciation escapes estate tax. However, it is important to consider what assets are funding a family’s current lifestyle. Identify those assets that won’t be missed and back into the appropriate assets to give from there.
It is important to keep in mind that even if a trust is structured so that a spouse is a beneficiary, the funds in the trust should be the last assets used, as the goal is to deplete the taxable estate before looking to protected assets. A qualified advisor can provide insight as to how to best gift, such as by first contributing assets to a family limited partnership, and then gifting a minority interest to obtain discounts on the transfer.