Understanding the Approaching Changes to Estate and Gift Tax Exclusions

Feb 19, 2024

By Katy Giesecke, CPA – Partner, Kyle Dixon, CPA – Senior, Tax, Marco Loza, CPA – Manager, and Haley Mulcrone, Associate, Tax

The lifetime estate and gift tax basic exclusions are set to undergo a significant reduction after 2025, a repercussion of the approaching sunset of the temporary provisions introduced by the Tax Cuts and Jobs Act (TCJA). The lifetime basic exclusion, often referred to as the “estate or gift tax exemption,” represents the amount of assets that an individual can transfer—either at death or as a gift during their lifetime—without triggering federal estate or gift taxes, which can reach a top rate of 40 percent.

The federal estate and gift tax exemption is adjusted annually to account for inflation. In 2023, the exemption was at $12.92 million per person. It increased to $13.61 million in 2024. Post-2025, with the TCJA provisions expiring, the basic exclusion amount is set to revert to the pre-TCJA benchmark of $5 million, adjusted for inflation from 2011. Projections for 2026 place the basic exclusion amount at an estimated $6.8 million.

An important clarification regarding gifts that are made under the current higher gift and estate tax exemption is that the exemption is not retroactive if it decreases in the future. In other words, gifts properly structured and completed by 2025 under today’s higher exemption amounts will not be negatively impacted when the exemption potentially drops in 2026.

This anticipated drop in the exemption amount could result in an increased number of moderately sized estates being liable for federal estate or gift taxes, barring any legislative amendments to extend or revise the current legislation.

Strategic Importance of Estate Planning

The expected reduction in the estate and gift tax exclusion underscores the importance of strategic estate planning. Below are several planning tactics aimed at reducing potential future estate and gift tax obligations:

  • Maximizing Current Exemption – Consider making large gifts or transfers under the current elevated exemption limits before they potentially decrease in 2026. Married couples could make gifts utilizing one spouse’s lifetime exemption while preserving the other’s exemption for future needs, thus reducing their aggregate tax exposure.
  • Intentionally Defective Grantor Trust (IDGT) is crafted to exclude asset growth from estate and gift taxes while attributing ownership to the grantor for income tax purposes. The “defect” is a consciously inserted right or power in the trust agreement that allows the grantor a degree of control over the assets. The transfer to the IDGT is a completed gift and is excluded from the grantor’s estate. The trust is treated as a grantor trust for income tax purposes and the grantor pays the income taxes on the trust’s earnings during their lifetime. This allows the assets in the trust to grow tax-free and excludes both the original assets and any appreciation from the grantor’s estate.
  • Spousal Lifetime Access Trust (SLAT) enables a married individual to contribute assets to an irrevocable trust, expressly for the benefit of their spouse. The grantor utilizes his or her gift tax exclusion to remove these assets from their taxable estate while allowing the grantor indirect access to the assets. A SLAT is generally treated as a grantor trust for income tax purposes like the IDGT, thereby reaping similar tax benefits. It is important to note that the trust’s irrevocability means that any changes in the spouse’s (beneficiary) circumstances, such as death or divorce, would result in the loss of the grantor’s indirect access to the trust assets.
  • Grantor Retained Annuity Trust (GRAT) is an irrevocable trust that allows the transfer of appreciating assets to beneficiaries with a cash flow advantage for the grantor. The grantor transfers assets to the GRAT and then receives fixed annuity payments for a set number of years. The amount of the gift tax exclusion used is the initial value of the assets, reduced by the present value of the annuity payments retained by the grantor. At the end of the term, the remaining asset value (growth and earnings) passes to beneficiaries, free of income, gifts, and estate tax. GRATs are ideal for assets likely to appreciate substantially in value. If assets underperform, there may be no residual value for beneficiaries.

The forthcoming reduction in the estate and gift tax exclusion is a crucial concern for those with considerable estates. Proactive estate planning can lessen the impact of these tax changes and ensure that wealth is preserved and passed on according to one’s wishes. Further estate and gift tax planning strategies will be discussed in the subsequent article. In the meantime, if you have any questions, the MichaelSilver Estate Planning team of professionals is equipped to guide you through the complexities of estate and gift taxes. We are here to help. Contact us at 847.982.0333.

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