Act Now Before the Estate Tax Exemption Sunsets
When the Tax Cuts and Jobs Act was passed in 2017, it called for several changes that limited and streamlined taxes for both businesses and individuals. It created the Section 199a deduction for pass-through companies, allowed for temporary 100% bonus depreciation, updated expensing rules for Section 179D, and called for a new employer tax credit for paid family and medical leave. There were also several important changes impacting individuals, including a reduction in the highest tax bracket and an increase in the federal lifetime estate and gift tax exemption. The cumulative effect was a welcome reduction in federal incomes.
However, many of these changes were only temporary and will expire at the end of 2025. One of the most prominent is the federal lifetime estate and gift tax exemption, which is currently at a historically high level. If congressional action is not taken to extend or amend the provision, it will create a myriad of challenges for high-net-worth families and individuals. To help clients, prospects, and others, Klatzkin has summarized the key details, including how to prepare for the future.
Sunset of Estate and Gift Tax Exemption
In 2017, the Tax Cuts and Jobs Act (TCJA) introduced nearly doubling the lifetime exemption for gifts and estates, from $5.6 million to $11.18 million for individuals. This amount was also indexed for inflation after 2018, bringing the current 2024 limit to $13.61 million, or $27.22 million for a married couple.
However, many provisions in the TCJA are set to expire at the end of 2025, including the exemption limit for estate and gift taxes. Unless there is additional congressional action, the exemption will return to pre-TCJA levels in 2026, which are expected to be around $7 million per individual, considering inflation.
If the sunset continues as planned, this could significantly impact high-net-worth individuals and families, making now the best time to revisit any estate planning. Taxpayers currently have an opportunity to use or potentially lose the higher exemption levels that are scheduled to drop after 2025.
Who Will Be Impacted by the Sunset?
The federal estate tax limits set to sunset are important for individuals with a “taxable estate” – an amount of retained wealth that will be passed on after death – above certain levels. Estates are exempt from tax below $13.61 million in 2024, for example, but anything above the amount is generally taxed at around 40%. Currently, taxpayers are subject to historically high exemptions, but this is set to change after 2025.
Differences Between Estate and Gift Taxes
In addition to estates, individuals can also transfer assets while living under the gift tax, which is subject to the same exemption amount as the estate tax. This unified exemption aggregate does not reset annually – all that is considered is the lifetime level of giving. However, it’s also important to note that only gifts in excess of $18,000 in 2024 must be reported as part of a taxpayer’s lifetime exclusion.
Timing Asset Transfer
Two elements of timing taxpayers should consider when planning asset transfers are the sunset of the current tax limit and the time value of money.
Not taking the TCJA sunset into account, the timing of transferring wealth is neutral for estate and gift taxes. This means that the total amount of tax that is paid will be the same, regardless of whether assets are transferred during an individual’s lifetime through gifting or at the time of death through estate bequests.
However, one benefit of transferring early is the time value of money. A dollar today is worth more than a dollar tomorrow due to the potential for appreciation and investment earnings. The appreciation on the asset after the gift is made is not subject to estate tax; only the initial gift is. This can significantly reduce the tax burden for beneficiaries.
Because early giving can be more beneficial and the exemption limits are scheduled to decrease significantly, it may be more advantageous for taxpayers to contribute to estates and transfer more gifts before 2026.
What Should High-Net-Worth Individuals Do?
Taxpayers who anticipate being affected by this change in limits should weigh the benefits of earlier, more significant lifetime giving against current and future liquidity needs. Working with an estate planner can help individuals and families chart a course for multiple scenarios and create a plan that will be most advantageous for the taxpayer’s estate and their beneficiaries.
One technique advisors may suggest for married couples, for example, is opening a Spousal Lifetime Access Trust (SLAT). One spouse gifts assets to the trust (as a donor spouse) and transfers ownership to the trust as a separate legal entity. The beneficiary spouse gains access to income generated by assets contained in the trust and sometimes gains benefits from the principal as well. This can provide some stability with lower liquidity, but again, every situation is different.
Contact Us
Now is the time to take action to ensure you are properly positioned if and when the estate and gift tax limits revert back to pre-TCJA levels. Since estate planning can be quite complicated, it is important to consult with a qualified advisor who can guide you through the process. If you have questions about the information outlined above or need assistance with another tax or accounting issue, Klatzkin can help. For additional information, call 609-890-9189 or click here to contact us. We look forward to speaking with you soon.