Favorable Estate and Gifting Opportunities? Is Time Running Out?

Alarm clock on row of paper money representing time running out on Estate Planning opportunity

Estate and gifting limits are at favorable levels right now, giving high net worth individuals ample estate planning opportunities. However, because of the uncertainty around potential tax reform that could be enacted as early as 2021, we encourage individuals to investigate acting on these current opportunities before the end of 2020.

What is the current estate exemption?

For 2020, the federal estate and gift tax exemption stands at $11.58 million per person, which means a married couple collectively has $23.16 million of estate exemption. This exemption amount covers the combination of gifts made during an individual’s lifetime and at death. Estates with assets more than the exemption amount are subject to a 40% federal estate tax.

In addition to the federal estate tax, high net worth individuals may also be subject to state estate taxes, as 12 states and the District of Columbia currently impose estate taxes.

Is the current exemption amount historically significant?

Yes. The Tax Cuts and Jobs Act (TCJA), passed in late 2017, temporarily doubled the “basic exclusion amount” (BEA) from a base of $5 million per person to $10 million per person. As a result, the estate exemption jumped from $5.49 million per person in 2017 to $11.18 million in 2018. For historical perspective, the estate exemption was only $3.5 million as recently as 2009.

Is the estate exemption scheduled to decrease in the future?

The estate exemption is scheduled to remain at an elevated level through 2025, at which point the exemption would revert to $5 million per person (adjusted for inflation) in 2026. However, a future administration could push to lower the exemption amount prior to 2026.

Will individuals who take advantage of today’s elevated exemption be penalized should the amount decrease in the future?

The Treasury Department and the IRS issued final regulations in November 2019 which clarified that individuals taking advantage of the increased exemption amounts from 2018 to 2025 would not be adversely impacted after 2025, should the exemption amount drop to pre-2018 levels.

Prior to the November 2019 final regulations, high net worth individuals were concerned that a “clawback” (tax) might apply should lifetime gifts exceed a future estate exemption. Per the IRS[1], “the final regulations provide a special rule that allows the estate to compute its estate tax credit using the higher of the BEA [basic exclusion amount] applicable to gifts made during life or the BEA applicable on the date of death.”

What is the advantage of moving assets out of one’s estate?

For individuals who are likely to one day have a taxable estate (i.e. assets in excess of the estate exclusion), the key advantage is reducing the portion of assets that would otherwise be subject to federal estate tax. The potential federal estate tax savings could be significant should the exclusion amount decrease sharply from the current limit of $11.58 million per person.

To illustrate the potential benefit, let’s consider a hypothetical example:

John Smith makes no lifetime gifts and dies in 2028 at which point the estate exclusion is hypothetically $6.5 million. At death, John’s estate is valued at $15 million. John’s final estate exceeds the exclusion by $8.5 million and is subject to an assumed 40% federal estate tax. Had John instead decided to gift $10 million in 2020 while the lifetime gifting exemption was much higher, he would have only had $5 million of assets exposed to federal estate tax – a significant tax difference of $1.4 million (calculated as (($8.5 million – $5.0 million) x 40%)).

In this simplified example, the hypothetical federal estate tax savings are a byproduct of an estate being able to use “the higher of the BEA [basic exclusion amount] applicable to gifts made during life or the BEA applicable on the date of death,” per the IRS clarification detailed above.

Who might consider gifting additional assets?

The ideal candidates are high net worth individuals who have assets in excess of the current $11.58 million lifetime gifting exemption and who have sufficient assets for the remainder of their expected lifetime. Individuals with more than $5 million in assets (the previous BEA (basic exclusion amount)) but below $11.58 million might weigh how much might be needed for their remaining lifetime against the potential benefit of additional gifting. Individuals with assets below $5 million may be less concerned over future tax reform and the impact on the federal estate exemption.

Aside from outright gifts to individuals, are there other strategies which might take advantage of the current estate and gift tax exemption?

The short answer is yes. Married couples could consider establishing Spousal Lifetime Access Trusts (SLATs), while single individuals could consider a self-settled trust. The basics of these trusts are beyond the scope of this article, though an experienced estate planning attorney should be able to help determine the viability of either trust strategy, in addition to other planning strategies such as installment sales, etc.

Is December 31, 2020, an important deadline to complete additional gifting?

The answer to this question is largely dependent on the outcome of the November 3 elections. A Democratic administration would likely look to reduce the current federal estate and gift tax exemption, while a Republican administration would likely maintain the status quo. It is unclear whether tax reform, if enacted, might be made retroactive to January 1, 2021, or if it would instead be made effective as of a future date, which would provide additional time for planning.

What does this mean for you? If you have not recently reviewed your estate plan, consider having a conversation with your estate planning attorney and your advisor as soon as possible to evaluate the potential benefit of gifting assets prior to year-end. You may need to wait until after the November 3 elections, when we may have a better sense of the potential for future tax reform, to determine whether to pursue any additional gifting this year.

If you have any questions, please call us directly at 770-368-9919 or email Cliff, cliff@cwoconner.com or Kevin, kevin@cwoconner.com.

[1] IRS. IR-2019-189, November 22, 2019

Cliff is the founder and president of C.W. O'Conner Wealth Advisors, Inc. Cliff earned a Bachelor of Business Administration degree in Accounting from Georgia State University.

Kevin O'Conner is a financial planner with C.W. O'Conner Wealth Advisors, Inc. He earned a Bachelor of Business Administration degree in Business Management from Georgia College, and is a Certified Investment Management Analyst (CIMA).