Beginning in 2018, the Tax Cuts and Jobs Act (TCJA) effectively removed gift and estate tax liability concerns for many families. However, the favorable estate tax changes in the TCJA are currently scheduled to sunset after 2025, unless Congress takes further action. Notably, the TCJA provision that doubled the gift and estate tax exemption from $5 million to $10 million (adjusted annually for inflation) will revert to pre-2018 levels after 2025.
The IRS has announced additional tax relief to families who could be adversely affected by large lifetime gifts during this timeframe. It has issued proposed regulations providing protection if you make large gifts that could erode future estate tax benefits.
Progression of the exemption amount
The gift and estate tax exemption has been increased substantially by several pieces of federal tax legislation since the turn of the century. After it was bumped up from $675,000 to $1 million, relatively small amounts by today’s standards, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 gradually increased the exemption to $3.5 million over the course of a decade. During the same period, EGTRRA lowered the top estate tax rate from 55% to 35% and severed the gift and estate exemption.
EGTRRA provided a one-year respite from estate tax — in 2010 — before the 2010 Tax Relief Act reinstated the exemption of $5 million and reunified the gift and estate tax exemptions. This law also introduced the estate planning concept of “portability.” With the portability provision, the estate of a surviving spouse can benefit from the unused exemption of a deceased spouse’s estate.
Subsequently, the American Taxpayer Relief Act (ATRA) of 2012 retained the $5 million exemption, indexed for inflation. Among other changes, this law also imposed a top 40% tax rate. But many of the gift and estate tax provisions in ATRA were temporary.
At long last, the TCJA provides even more gift and estate tax relief. Under the TCJA, the exemption was doubled from $5 million to $10 million, indexed for inflation, while retaining the portability provision and the top 40% tax rate. The IRS has announced that the exemption for 2019 is $11.4 million (up from $11.18 million in 2018).
This gives most families plenty of estate planning leeway. For instance, a married couple can effectively shelter up to $22.8 million from gift and estate taxes in 2019. However, in 2026, the exemption is set to return to the 2017 level of $5 million, adjusted for inflation.
New relief provided by the IRS
Generally, the exemption is first used during your lifetime to offset any gift tax. The remaining amount is then used to reduce or eliminate estate tax. But what happens if you make large gifts between 2018 and 2025 that are sheltered by the higher exemption amount but become unsheltered when that amount is reduced beginning in 2026?
To address concerns that estate tax could apply to gifts exempted from gift tax by the increased exemption amount, proposed regulations clarify that individuals who take advantage of the increased exemption won’t be harmed after 2025 when this amount is scheduled to drop. Under a special rule in the regs, an estate can effectively compute its estate tax by using the greater of the exemption amount applicable to gifts made during your lifetime or the exemption amount applicable on the date of death.
As a result, if you plan on making large gifts in the next few years, you don’t have to worry about losing the tax benefit of the higher exemption amount after it decreases in 2026. For example, let’s say that you didn’t make any gifts prior to 2018. When the exemption amount was $11.18 million last year, you gave your children $9 million and paid zero gift tax. If you die in 2026 or thereafter, your estate can still base its estate tax calculation on the higher exemption amount that was effective in 2018.
You can rely on these proposed regulations until final regulations are issued. The IRS has requested comments from the public.
Consider both the long-term and short-term gift and estate tax implications of the new regs. This should encompass large gifts contemplated over the next few years as well as the need for eventual estate tax protection. With assistance from your estate planning advisor, you can minimize or eliminate potential estate tax liability.
Don’t forget the gift tax exclusion
Avoiding gift tax during your lifetime is a major component of estate planning. However, before sheltering gifts using your gift and estate tax exemption, remember to take advantage of the annual gift tax exclusion. This provision is applied before your exemption amount is eroded.
Under the gift tax exclusion, you can give each recipient up to $15,000 in 2019, exempt from any gift tax liability. For instance, if you have two children and four grandchildren, you can give each one $15,000 free of gift tax, for a total of $90,000.
Furthermore, this annual exclusion is effectively doubled for joint gifts made by a married couple. Thus, you and your spouse can give away a total of $180,000 tax-free in 2019. If you continue this gift-giving pattern for five years, you’ll have reduced your joint estate by $900,000 — plus any appreciation on the assets transferred — gift-tax-free.