To Gift or Not to Gift – The Current Dilemma
As we begin the new year, many individuals have begun to wrestle with the question of how to prepare for a possible reduction in the current estate and gift lifetime exemption. Should they gift it all, gift a little, or not at all?
Current estate tax rules are based on the Tax Cuts and Jobs Act (TCJA) of 2017. With the TCJA, taxpayers saw a significant increase in the estate and gift tax lifetime exclusion that’s indexed for inflation. For 2021, the exclusion has now reached $11.7 million per person; therefore, a married couple now has a combined $23.4 million exclusion. This change has given many individuals great comfort that their estates won’t be subject to estate tax. However, this TCJA provision is scheduled to sunset after December 31, 2025, and if that occurs, the exemption will revert to $5 million per person, indexed for inflation (or approximately $6 million per person). In addition, the administration of President-elect Biden has indicated its tax plan would include a return to a more “normal” exemption amount that many commentators believe could be $3.5 million if passed.
Finally, the IRS has issued final regulations confirming that individuals who take advantage of the increased estate and gift tax exemptions in effect currently won’t be adversely affected after 2025 (or presumably earlier with tax reform change) when the exclusion would drop to much lower levels. All of this has caused taxpayers to consider whether to use it all now before losing it.
Facing those possibilities, what planning should be considered?
Estates Below $3.5 Million
For individual taxpayers whose net worth is below $3.5 million (and not likely to grow substantially in future years), the answer can be simple. Only gift if you truly desire to gift or if there are other non-tax considerations that make gifting appropriate as there will likely be no estate tax owed upon death (assuming no state estate/inheritance tax exists). Currently, all estates regardless of size receive a “step-up” in basis at death, so retaining assets until death could save income taxes for your heirs in the future. Some taxpayers have even considered whether existing irrevocable trusts can be modified or terminated to allow the assets to be considered taxable at an individual’s death in order to obtain a stepped-up basis in those assets. As President-elect Biden takes office, planning for step-up must be done cautiously because his campaign proposals also indicated a desire to eliminate the step-up in basis rules.
Estates of $3.5 Million to $11.7 Million
For taxpayers whose taxable estate is below the current exemption of $11.7 million ($23.4 million for a married couple) but above $3.5 million ($7 million for a married couple), the decisions may be harder. Perhaps they can’t afford to make gifts to fully use the current exclusion due to current cash flow needs or are nervous about losing access to all the assets and income. When planning, we also must keep in mind how a current gift uses the lifetime exclusion and how much exclusion would be left after a reduction in the exemption.
For example, if John has made no prior gifts and chooses to make a gift of $6 million in 2021, he would have $5.7 million of exclusion remaining ($11.7 million minus $6 million, used from top down) under current rules. But if the exemption were to drop to $6 million in the future, he would have no exemption remaining ($6 million less $6 million used for prior gifts).
Strategies to consider for these situations include having one spouse fully use their exemption while preserving the other spouse’s exemption. This could be done by an outright gift(s) if there are enough remaining assets to support the couple. Another structure would be for one spouse to gift assets to a Spousal Lifetime Access Trust (SLAT), which would allow the other spouse to be a beneficiary along with children or grandchildren and have potential access to the income earned by the trust if needed. When gift tax returns are filed, the couple would not elect to split the gifts, so the spouse creating the trust would use all of his/her exemption and the other spouse’s exemption would remain intact and available in the future. With this planning, practical concerns such as each spouse’s life expectancy and potential for divorce must be considered when evaluating appropriate planning.
For single taxpayers, the planning can be more difficult, but consideration must be given to lifestyle, life expectancy, and assets available for planning. Possible options to reduce the estate but retain access to cash flow/assets are gifts to a grantor-retained annuity trust (GRAT), sale of assets to an intentionally defective grantor trust (IDGT), or transfer of a home to a qualified personal residence trust (QPRT). Another option to explore is a gift in trust if the trustee could have the power to loan money back to the donor, if needed.
Estates Above $11.7 Million
For taxpayers with estates in excess of the current generous exemption, more flexibility may exist. They may have the ability to gift all of their remaining exemption currently with less worry about lifestyle limitations in the future. However, enhancing the full usage of the exemption may become more of the concern, i.e., desire to gift as much as possible, due to the dollar amounts involved. Similar strategies mentioned above such as GRATs, sale to IDGTs, and QPRTs can still be used. To enhance assets transferred, taxpayers also can consider forming family limited partnerships to hold various assets and then using the gift/sale of partnership units that could take advantage of marketability and minority discounts. In addition, gifts of closely held business interests can potentially take advantage of similar discounts.
There are many factors to consider when it comes to estate planning. All these strategies take much planning and care to help ensure your ultimate wealth transfer goals are met. Reach out to your BKD Trusted Advisor™ or submit the Contact Us form below to discuss whether any of these options could support your estate planning goals.