For financial advisors, trying to see around corners of potential tax legislation is crucial in helping clients craft effective estate plans. How much more crucial is such a skill in these extraordinary times?
Changes could be brewing when it comes to estate and gift tax exemption amounts — changes that could mean a significant reduction in how much wealthy clients and their families can transfer to rising generations without taking a significant tax hit.
The federal estate, gift and generation-skipping transfer tax exemption amounts are currently set at $11.58 million per individual or $23.16 million for married couples. That means that federal tax is not owed on the transfer of assets below those thresholds.
As they now stand, those exemption amounts are currently set to increase annually through 2025. On Jan. 1, 2026 the exemptions are set to revert to $5.6 million, indexed for inflation from 2018.
However, the coronavirus and resulting economic crisis has triggered trillions of dollars of government stimulus spending that will have to be paid for eventually, even as the severe economic contraction has resulted in federal and state budgets being slashed. Some economists are predicting that taxes will have to increase to help pay for massive stimulus measures and the shoring-up government coffers.
Here’s the bottom line: Financial advisors shouldn’t be complacent about the current 2026 sunset date of the GST tax exemption amounts. In my opinion, current estate and gift tax exemption amounts may very well be on the chopping block — and well before 2026.
Depending on the factors I’ve mentioned above and the results of the election this November, significantly lower estate and gift tax exemption amounts could be enacted even as soon as next year.
Economy + election = ?
Granted, this is only speculation at this point. But advisors with wealthy clients should explore utilizing exemptions now, as this could become a “use-it-or-lose-it” scenario sooner than expected.
Although some clients may want to wait until after the November elections to make a decision, we recommend working with clients now to think through their options and even get documents ready so clients have the option to execute their wishes efficiently post-election.
Start the discussion by working with your client by exploring how and how much to give in the event that the GST tax exemption expires earlier than the current sundown date of 2026.
Gifts can be made outright or to a trust for the benefit of descendants or a spouse. If a family already has irrevocable trusts in place it may be possible to use those trusts to reduce the time and expense involved in making a transfer.
As stated above, the estate and gift tax exemption could become a “use-it-or-lose-it” scenario sooner than otherwise anticipated. If the exemption amounts are reduced, any gifts made in the past will count against the new lower exemption amount.
Therefore, if a married couple can afford to use both spouses’ remaining gift tax exemption — a total of $23.16 million less any exemption allocated to previous transfers — they should.
If the couple can’t, or is not comfortable, using both exemptions, it is more tax efficient to have one spouse use the exemption in full, with the other giving what they can rather than making gifts in equal amounts.
Because splitting gifts is a fairly common way to give, we also recommend reviewing 2019 gifts, if that return hasn’t been filed yet, as part of this analysis.
Which assets to give
All things being equal, it is best to gift assets with the greatest likelihood of appreciation, as all future appreciation escapes estate tax.
However, it is important to consider which assets are funding a family’s current lifestyle. Identify those assets that won’t be missed and back into the appropriate assets to give from there.
It is important to keep in mind that even if a trust is structured so that a spouse is a beneficiary, the funds in the trust should be the last assets used, as the goal is to deplete the taxable estate before looking to protected assets. Consider first contributing assets to a family limited partnership, and then gifting a minority interest to obtain discounts on the transfer.
