Give it away now? The sunset of the gift and estate tax exemption is around the corner (2023)

We don’t yet know what the indexed amounts will be for 2024 and 2025. If the indexing in a high-inflation environment — an $860,000 increase from 2022 to 2023 — is any indication, the increase could again be significant. These numbers are typically released in the fall, so come October 2023, we will know what the exemption for 2024 will be.

What we do know with certainty is that the gift, estate and generation-skipping transfer tax exemptions are currently scheduled to be reduced to $5 million per person ($10 million for married couples), plus indexing, starting in 2026. For planning purposes, we estimate that the exemption will be roughly cut in half, perhaps from $14 million in 2025 to $7 million in 2026.

Examples

What’s at stake for those who can afford to use the higher exemption prior to Dec. 31, 2025? And what needs to happen prior to that date? Let’s consider the following examples.

Adam and Barb: Use of the full exemption

Adam and Barb, both 64 years old, have a net worth of $50 million. They have a great amount of liquidity, mostly in the form of publicly traded securities. While they have taken advantage of the annual gift tax exclusion for kids and grandkids ($17,000 per person, free of gift tax), they have not used any portion of their gift tax exemption.

To take advantage of the increased exemption, Adam and Barb will need to make additional gifts prior to Dec. 31, 2025, likely to an irrevocable trust to benefit their family.

Let’s look at the numbers. The “do nothing” column assumes Adam and Barb do not make gifts prior to the second death. And the “gift planning” column assumes Adam and Barb use their full projected exemption in 2025.

This example has both Adam and Barb dying in 2026. This “worst-case” scenario provides the simplest explanation of the benefit of using the exemption prior to Dec. 31, 2025. Gifting prior to 2026 allowed Adam and Barb to use $14 million more of their lifetime exemption without incurring any additional estate tax. Should Adam and Barb live beyond 2026, they could benefit from inflation increases on the remaining exemption, which could also be offset by the future growth of their estate. Also, the possibility of future legislation could reduce or otherwise change the exemption, increase the estate tax rate or create another form of wealth tax.

Carly and John: Use of one spouse’s full exemption

Carly, 55, and John, 56, are married and have a net worth of $25 million. Approximately half of their net worth consists of Carly’s closely held business. Carly has been developing a plan to transition her business to her two children, who are 31 and 29.

While giving away the entirety of their net worth is clearly not an option, they are willing to consider using one of their increased exemptions prior to Dec. 31, 2025. Here is what the math looks like if Carly makes a gift of the nonvoting portion of her business to an irrevocable trust for the benefit of their children:

As can be seen from this example, there is still a significant benefit even in using one spouse’s increased exemption.

Moreover, some married couples will establish an irrevocable trust known as a spousal lifetime access trust (SLAT) to give themselves even more flexibility if circumstances change, allowing the nongifting spouse to be a trust beneficiary. Notably, this strategy only works if gift-splitting is not elected on the gift tax return and, for taxpayers in community property states, a reclassification of community property as individually owned property prior to gifting will likely be required.

Anti-clawback

Since the time that the TCJA was enacted, the estate planning community has pondered the question as to what the implications would be for clients who used more exemption during their lifetime than was available to them at death. The possibility that the IRS would treat the excess gifts as part of the taxpayer’s estate was even given a name: clawback. On Nov. 26, 2019, the IRS adopted a special rule known as the anti-clawback rule confirming that it would not in fact bring these gifts back into the estate. In April 2022, this rule was clarified in proposed regulations and it was confirmed for true lifetime gifts (i.e., those where the taxpayer does not retain possession and enjoyment of the transferred asset).

For more, see our article on the proposed IRS regulations that would claw back the exemption for certain taxpayers.

Next steps

Contemplating the entire estate planning process can undoubtedly be daunting. At Baker Tilly, estate planning professionals are available to assist you with your plan, including some of the critical steps in the gifting process:

• Valuations of real estate, closely held business interests or other assets that require valuations.
• Advising on which assets would be the best for gifting. In addition to the loss of cash flow or control of an asset, another consideration is the fact that assets given away to an irrevocable trust will not receive a step-up in basis at death.
• Financial planning and cash flow analysis: How much can you afford to give away and still maintain your lifestyle?
• Properly reporting your gifts on Form 709 (the federal gift tax return)

Questions?