When making year-end tax planning decisions, many individuals were depending on the November election results to provide insight into future tax legislation, including how it may impact estate tax exemptions. In the absence of a decision about Senate control by the end of 2020, here are several important considerations when determining whether to gift or take other action prior to year-end.
Estate-tax exemption: Potential changes and impacts
The Tax Cuts and Jobs Act (TCJA) was enacted in 2017 and doubled the base amount of the gift and estate tax exemption. Prior to the TCJA, the estate tax exemption was $5 million per person, indexed for inflation. Beginning in 2018, the TCJA doubled the estate tax exemption to $10 million, indexed for inflation. The 2020 estate tax exemption is $11.58 million per person and will increase to $11.7 million per person in 2021, assuming no further tax legislation. However, in 2026, the base amount of the estate tax exemption will revert to the pre-TCJA exemption of $5 million per person. President-elect Biden has discussed a reduction in the estate tax exemption to “historical norms” without elaborating or designating a specific dollar amount. A review of past estate tax exemption amounts yields a wide range, which can’t offer much insight when trying to predict a potential new amount. Focusing on recent history, it’s possible that Biden-backed legislation would set the estate tax exemption to $5 million per person (that is, the amount immediately preceding the TCJA) adjusted for inflation or to an even lower amount.
Many individuals who could be impacted by a reduction are contemplating making large gifts while the estate tax exemption is at a historical high.
In concrete terms, individuals with a taxable estate currently would owe an additional $400,000 at the time of death for every $1 million the estate tax exemption is reduced. Many individuals who could be impacted by a reduction are contemplating making large gifts while the estate tax exemption is at a historical high.
Further adding to the uncertainty is the question of when any potential new tax legislation would be made effective and whether it could be made retroactive to January 2021. Historically, retroactive legislation has mainly impacted income tax legislation and not the estate tax system. But if estate tax exemptions legally can be reduced retroactive to Jan. 1, 2021, the only way for individuals to be certain they can use the higher exemption is by gifting assets prior to 2020 year-end.
Time constraints are impacting individuals’ selections of assets to gift and the gifting vehicle.
The time constraints are impacting individuals’ selections of assets to gift and the gifting vehicle. Ideally, an individual would gift highly appreciating assets. Unfortunately, many times the asset with the most appreciation potential owned by an individual is a closely held entity, and it may not be possible to complete a valuation prior to year-end. This means individuals may instead want to gift cash or marketable securities to ensure the gift can be completed in time and in the desired amount. There may be options to peg an amount of ownership to a specific dollar amount, but these provisions require careful drafting and have been scrutinized by the IRS in the past.
Individuals may instead want to gift cash or marketable securities to ensure the gift can be completed in time and in the desired amount.
At this point, individuals may also be limited in gifting directly to children and other family and friends or to an already established irrevocable trust. And with the short time left in 2020, it may not be possible to have a new irrevocable trust drafted, signed, and funded prior to December 31.
Even if estate tax legislation remains unchanged in 2021, individuals who may have taxable estates may have to contemplate the same decisions in 2022 as a result of the midterm elections or in 2025 when the portion of the TCJA related to the estate tax exemption sunsets.
Even if estate tax legislation remains unchanged in 2021, individuals who may have taxable estates may have to contemplate the same decisions in 2022.
Individuals unable to complete gifts prior to 2020 year-end may continue to gift into 2021 with the hope that gifts made prior to the enactment of any tax legislation will not be impacted. In addition, the continuing low interest rate environment means that certain wealth transfer techniques, including some who don’t use the estate tax exemption, have a higher chance of accomplishing one’s tax reduction and wealth transfer goals.
If you would like additional information on wealth transfer planning or have any questions, feel free to give us a call.