Don’t Let the Sun Go Down

Answer: The answer to your question is “it depends” meaning this is a good time to review your estate and gifting plans. If Congress doesn’t take any action, the exemption for federal estate tax will be reduced by half after 2025. Let’s back up a moment and talk about how the current lifetime estate and gift tax exemptions operate. 

The Tax Cuts and Jobs Act of 2017 (TCJA) created generous and favorable estate and gift tax exemptions which are scheduled to sunset at the end of 2025. Other changes in the law included an increase in the standard deduction, charitable giving deductions, and reductions in individual income tax rates that could be adjusted as well if there is no action taken by Congress. 

TCJA Explained

The TCJA went into effect January 1, 2018, doubling the estate and gift tax exemption from $5 million to $10 million for individuals and $10 million to $20 million for joint filers. The exemption is indexed for inflation meaning the 2024 estate tax exemption is $13.61 million for individuals and $27.22 million for married couples. In addition, you may make annual gifts up to $18,000 per recipient in 2024 without using any of your gift tax exemption. With many tax provisions scheduled to revert back to pre-TCJA levels in less than two years, consider moves you might need to make to minimize your tax burden and support your financial goals.

Tax Planning

TCJA is scheduled to sunset December 31, 2025, meaning the estate tax exemption in 2026 will fall back to $5 million for individuals and $10 million for couples, indexed for inflation, unless Congress acts to extend the provisions.

How the exemption changes work

Example: If in 2023 a married couple with $25.84 million in assets gifted $17,000 to a child,  (the amount of the gift tax exemption in 2023), they didn’t pay gift taxes on that gift. They also made a second gift that year to their child of $25,823,000 – the remaining amount of their lifetime estate and gift tax exemption (as of 2023). 

Did the couple have to pay taxes on that generous second gift? No. Even though the second gift is taxable, the IRS applies a credit against the gift tax based on the total estate and gift tax exemption. In other words, the IRS in effect says to such a couple, “You don’t need to pay now for that taxable gift; we’ll settle up with you on all your lifetime gifts and estate taxes when you die.”

What if they passed away in 2024? The TCJA is still in effect, and the couple’s estate ends up paying nothing in gift or estate taxes for either the first or second gift because those two gifts equal $25.84 million, which is less than the 2024 lifetime gift and estate tax exemption of $27.22 million. If their remaining assets at time of death are $1.5 million, their estate wouldn’t pay taxes on $1.38 million of those assets because they’re covered under the remainder of the $27.22 million exemption.

What if this couple dies in February of 2026 after the TCJA has ended, and Congress hasn’t acted to extend the provisions? Assuming the indexed gift and estate tax exemption for 2026 is $10.4 million, does the TCJA expiration mean the couple now has to pay taxes on the amount of their second gift that is above $10.4 million? No. The IRS issued a rule in 2019, clarifying that it won’t “claw back” gifts made while TCJA was in effect. So, the estate in 2026 can calculate its gift and estate tax exemption using the exemption under the TCJA.

Gifts and other strategies

Outright gifts aren’t the only option to take advantage of the high lifetime gift and estate tax exemption under the TCJA. Based on your circumstances and goals, you may want to consider several other strategies.

Gifts to an irrevocable trust

An irrevocable trust with designated beneficiaries and distributions based on the terms you choose allows you to make gifts and take advantage of the TCJA lifetime gift and estate tax exemption.

Gift to a spousal lifetime access trust (SLAT)

Worried that making large gifts to others or a trust might leave you short on funds? You may want to consider a spousal lifetime access trust (SLAT). The SLAT is created by one spouse for the benefit of the other spouse. Any gifts the SLAT creator puts into the trust will be distributed to the beneficiary spouse, who can then use those distributions for joint expenses. You can also configure a SLAT so that its assets pass to your descendants upon the death of both you and the beneficiary spouse. Gifts the donor sponsor gives to the SLAT are exempt from tax up to the donor spouse’s available exemption amount. In 2024, a donor could gift $13.61 million without paying a gift tax.

While the donor won’t be taxed on contributions below the exemption amount, the beneficiary may well owe tax on distributions from the SLAT, as these are treated as taxable income. And assets distributed to the beneficiary spouse can increase their estate. That increase could be subject to the estate tax or its exemption.

Establishing other types of trusts

Other trusts that may meet  your needs include dynasty trusts, irrevocable life insurance trusts, and a qualified personal residence trust. Again, discuss these techniques with your team of financial professionals. 

If gifts to your SLAT will use up your gift and estate exemption, but you also have a significant life insurance policy, an irrevocable life insurance trust (ILIT) may be a way to prevent the life insurance policy from counting as part of your estate. That way, your beneficiaries benefit from the life insurance payout without being subject to high estate taxes.

A good time to review your estate plan

There’s a good chance that new tax legislation may take effect between now and 2026 to extend or build upon the TCJA provisions. It’s still advisable for families to review their estate plan. Waiting until the latter months of 2025 might limit available strategies to take advantage of the TCJA estate tax exemption provision. Even if you’re confident that the TCJA sunset won’t affect your estate plan, it’s still important to check it regularly. 

Yes, this is complex planning and should be discussed with your trusted CERTIFIED FINANCIAL PLANNER™ Professional, CPA and Estate Planning Attorney. If you act before 2026, you may be able to take advantage of the TCJA to lock in its higher lifetime gift and estate tax exemption even if you expect to live long past December 31, 2025. Stay focused and plan accordingly.