By Chris Madrid, CPA, Director, Tax & Advisory
ASL Family Wealth & Individual Tax Group
“Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes“. This is a famous quote by Benjamin Franklin and it still holds true today. However, what is currently uncertain is what will happen to the amount of estate and gift lifetime exemption and how to effectively estate plan now in light of that uncertainty.
The Tax Cuts and Jobs Act (TCJA) passed in late 2017, nearly doubled the lifetime estate and gift tax exemption from $5.6 million to $11.18 million for individuals, indexed for inflation after 2018. For 2023, the indexed exemption rose to $12.92 million ($25.84 million for married couples) and it is slated to be as high as $13.61 million in 2024 ($27.22 million for married couples).
On January 1, 2026, this significantly high exemption amount set under TCJA is scheduled to sunset. It is projected to drop from the current exemption amount to only $5 million ($10 million for married couples). Those figures are expected to be adjusted for inflation, which, based on current estimates will lead to an exemption amount of $6.08 million ($12.16 million for married couples).
This change will potentially affect estates over the current exemption amount of $12.06 million as well as estates that are in the six million to twelve million dollar range, as they may be subject to estate taxes again if Congress allows the current exemptions to sunset.
Planning Technique #1 – Making Gifts
Making lifetime gifts now to take advantage of the increased exemption amounts will remove not only your assets from estate taxation but also any appreciation on said assets.
The IRS has issued regulations (Regs. Sec. 20.2010-1(c)) to prevent a clawback on your lifetime gifts made during the increased exemption period. The regulations allow you to make gifts over the lower 2026 exemption amount and up to the current exemption amount without worry that your estate will claw back the excess exemption used. Your estate would be granted an exemption amount up to the amount of excess exemption used.
Lifetime gifts made now in anticipation of the lower estate and gift tax limit will need to exceed the reduced exemption to reap estate and gift tax benefits.
For example, you make lifetime gifts of $10 million in 2023 and pass away in 2026 when the exemption amount has reverted to $6.2 million. Because you made the gift in 2023 while the exemption was $13,610,000, your estate will get the benefit of the estate tax exemption of $10 million and not just the $6.2 million. You will have passed an additional tax free gift of $3,800,000 and saved $1,520,000 in estate and gift taxes.
Planning Technique #2 – Setting up Specific Types of Trusts
There are opportunities for sophisticated estate planning techniques that involve creating specific types of trusts.
If you are married, a spousal lifetime access trust (SLAT) is one tool for removing wealth from your estate while retaining access to it. A SLAT is an irrevocable trust, established by the trustor spouse for the benefit of their children or other heirs. This type of trust permits the trustee, who cannot be the trustor spouse to make distributions to your spouse, indirectly benefitting you as well as your spouse with income. The trust removes the assets from both the estate of the trustor spouse and from the spouses’ estate, as he/she only has a right to the income during his/her lifetime.
However, this type of trust must be funded only with separate property. California is a community property state, so you may first need to convert community property assets into separate property assets, typically via a so-called partition agreement. If you and your spouse both want to create a SLAT to benefit the other, beware the so-called reciprocal trust doctrine. Spouses cannot create substantially similar trusts. Any trusts found to be in violation of the doctrine will be ignored for federal tax purposes.
These trusts are irrevocable. If the non-trustor spouse dies first, the trustor spouse would lose access to the trust assets.
The SLAT is just one example of trusts that can be used to gift. You can also establish traditional trusts for the benefit of children and grandchildren. Specific types of grantor trusts can also be used to remove assets from your estate. To be a completed gift, you will have to give up the income and the ownership of the property.
Planning Technique #3 – Charitable Bequests
Consider ways to reduce estate taxes by incorporating charitable giving into you estate plan. You may want to consider leaving an IRA to a charity. We suggest that you reach out to your estate tax attorney to discuss potential planning opportunities.
In closing, the Family Wealth & Individual Tax Planning Group at Abbott, Stringham & Lynch is here to help you navigate the complexities and planning opportunities related to estate planning for the future. Please contact us for more information and assistance.