The past few years have been a roller coaster between the pandemic, the California wildfires, and the political climate. We have seen massive tax acts enacted, including the Tax Cuts and Jobs Act of 2017 that doubled the estate and gift tax exemption to $11.7 million for single filers and $23.4 million for joint filers (indexed for inflation).
2021 Tax Year
The estate planning environment has been very favorable. In the tax year 2021, as the law currently stands, a married couple with a combined estate of $23.4 million would be able to gift or pass their estate to their heirs without estate tax consequences. These assets, in the hands of the heirs, receive a step-up in basis and there will be little or no income tax imposed upon the sale of these assets. This couple, alternatively, can make gifts during their lives up to the amount of the lifetime exemption with no gift tax consequences. However, making lifetime gifts means the donee receives the gift at the donor’s cost basis.
If a spouse passes away in 2021, and his/her taxable estate is under $11.7 million, the executor can file an estate tax return and elect to carry the unused portion of the estate tax exemption to the surviving spouse. The surviving spouse is able to use this carryover portion, plus their own lifetime exemption, to make gifts during their life. The remaining combined exemption can be used to shelter assets from estate taxes upon the second death.
Here’s an example
A husband and wife have a combined estate of $14 million dollars. The husband dies in 2021, and an estate tax return is filed for his estate. His taxable estate is $7 million dollars, which means the additional unused exemption of $4.7 million is now available for the surviving spouse, increasing her exemption to $16.4 million dollars (her $11.7 plus his unused exemption).
We started the year 2020 with a Democratic House of Representatives, a Republican-controlled Senate, and a Republican President. By the end of the year, a Democratic president was elected, which would signal a push for a change in tax policy. However, to be able to push through any sweeping tax changes, the control of the Senate would need to change, which at the end of 2020 seemed unlikely. And yet, in January 2021, the unlikely happened. We now have a Democratic President as well as a House and Senate with a Democratic majority. Therefore, some changes in tax policy are to be anticipated.
President Biden’s tax proposal includes expanding the imposition of estate and gift tax by restoring the rate and exemption to 2009 levels, thus reducing the lifetime exemption to $3.5 million, and increasing estate and gift tax rates to 45%.
So what do you now?
We recommend doing an analysis of your existing assets and coming up with a gifting plan. In doing this, the gift during the current year, plus prior gifts made, must be large enough to exceed the projected exemption amount, or nothing has been accomplished.
If Biden’s proposed reduction to the estate and gift exemption passes, individuals should plan to give away more than that amount to take advantage of the current larger exemption amount.
If no gifting is done prior to any prospective changes to the exemption, gifts in the future will potentially be limited to $3.5 million. If only $3 million is given away prior to changes, all the individual has accomplished is the utilization of the new and much lower exemption amount.
Under current law, all taxpayers have a 2021 estate and gift tax exemption of $11.7 million dollars. Let’s say a taxpayer makes gifts of $10 million prior to enactment of the proposed exemption reduction to $3.5 million. When the exemption limit is lowered to $3.5 million, the taxpayer’s exemption has been exhausted at this point. However, the individual has still managed to take advantage of some of the existing large lifetime exemption amount, and remove $7 million dollars from his/her taxable estate. The IRS has currently indicated that there “probably” will not be an attempt to pull the $7 million back into the estate.
As with any estate and gifting plan, every person’s situation is different depending on the assets that they own. In addition, there are non-tax reasons to consider when making a gifting plan, such as the wishes of the donor, or the legacy they want to leave for their heirs. We recommend working with an attorney as well as your financial and tax advisors. Contact one of the members of our Family Wealth and Individual Tax Group with any questions.