Couples have unique option to plan for risk of future higher estate taxes

Bill Cass, CFP®, CPWA®

Bill Cass, CFP®, CPWA®, 04/26/23

Since 2018, the amount of assets taxpayers can shelter from federal gift and estate taxes during their lifetime (known as the Basic Exclusion Amount, or BEA) has dramatically increased. The Tax Cuts and Jobs Act (TCJA) doubled the exclusion amount from $5.5 million in 2017 to $11 million in 2018.

Today, due to annual inflation adjustments, the figure stands at $12.92 million for 2023.

However, since much of the tax code sunsets at the end of 2025, the exclusion amount is set to revert back to the 2017 figure, adjusted for inflation, which would be roughly $7 million.

Federal BEA for gifts and estates

federal estate tax limit

Use it or lose it

The expiring tax law provides a planning dilemma for high-net-worth households concerned about the future impact of the federal estate tax. In light of the scheduled reduction in the BEA at the end of 2025, do large lifetime gifts make sense before the amount is reduced? Since the top marginal tax rate on estates is 40%, removing assets from an estate may result in significant savings, potentially several million dollars.

Making sizable gifts requires careful consideration since these are generally irrevocable decisions. What if Congress passes legislation to extend the current BEA beyond the 2025 deadline? For instance, in the early days of 2013, the American Taxpayer Relief Act (ATRA) was signed into law and avoided a reduction in the BEA.

Another key question is whether large lifetime gifts, made under the temporary increase in the BEA, would potentially be clawed back into the estate of the party making the gift once the tax law sunsets in 2025. The Treasury Department addressed this by confirming that no clawback rule would apply in this case.* This provides HNW families with an option to manage future federal estate taxes by using the increase in the BEA to make large lifetime gifts now, before the law sunsets or a future Congress changes the rules. In addition, since estate and gift taxes were not repealed with the passing of the TCJA, many HNW clients may feel that a federal estate tax repeal is unlikely at this point.

A potential planning option for spouses

The challenge with removing assets from an estate is the person making the gift has to generally relinquish control over that property in order for the transaction to be considered a completed gift for estate and gift tax purposes. Those considering large gifts may have second thoughts if faced with the prospect of losing use and control of those assets in the future. This is where a spousal lifetime access trust (SLAT) can provide benefits. If structured properly, transferring property from one spouse to the other via a SLAT can reduce a taxable estate by removing assets from the donor spouse, who may also benefit indirectly from the property held within the trust. At the death of either spouse, assets held within the SLAT are not considered part of either estate.

spousal lifetime access trust illustration

While a properly structured SLAT can be an effective tool to mitigate estate taxes, there are important factors to consider. For example, what happens if the recipient spouse pre-deceases the donor spouse? In that case, the donor spouse may lose indirect access to those assets. Or, what happens in the case of a divorce? These issues highlight the need to work with a qualified estate planning attorney to determine if this type of strategy makes sense for a particular set of circumstances.

*In April 2022, the Treasury Department issued proposed regulations that would modify the anti-clawback rule imposed on gifts prior to the sunset of the TCJA in 2025. These proposed rules would mean that certain transfers after 2017 and before a scheduled reduction of the BEA in 2025 could be considered part of a taxable estate. An example includes a gift that provides a retained interest to the grantor, such as a grantor retained annuity trust, or GRAT. For more details, refer to proposed regulations see the federal register.