Before the Sunset
Do you remember the Tax Cuts and Jobs Act (TCJA) of 2017? Among other provisions, the TCJA increased the federal estate, gift, and generation skipping tax exemption from $5 million to $10 million, adjusted for inflation, with a maximum tax rate of 40%. The increased exemption, inflation adjusted using the Consumer Price Index (CPI), is currently $11.7 million per person.
What you may not remember is this increased exemption is scheduled to “sunset” on December 31, 2025, reverting to the prior exemption of $5 million per person. When adjusted for CPI increases, the exemption will be approximately $6 million by January 1, 2026.
With the Biden administration in place and Democratic control of Congress, it is possible that before the sunset in 2025, the exemption will be reduced to $3.5 million with an increased maximum tax rate of 45%, the amount Biden proposed during his campaign.
However, currently the administration is focused on raising rates on capital gains, corporate income, and personal income, plus proposing to end the step-up in basis, which allows heirs to use the market value of assets at the time of death, rather than the purchase price paid by the estate owner, as the cost basis for capital gains when the assets are sold. The Biden proposal would require estates to pay capital gains tax on unrealized gains of more than $1 million, or $2.5 million per couple when combined with existing real estate exemptions. As proposed, heirs who continue to operate family owned farms and businesses may not be subject to capital gains tax on these assets.
Consider Using the Exemption During Lifetime
The federal estate, gift and generation skipping tax exemption is available for use during lifetime or at death. Because the exemption is used first during lifetime to offset gift tax, consider with your estate attorney and financial advisor making gifts prior to the sunset and prior to the potential loss of the step-up in basis. Ideally, make gifts of assets with appreciation potential, not only reducing your current taxable estate but removing the appreciated value from your estate as well. The Internal Revenue Service has indicated that gifts made under the current exemption will not be subjected to federal estate tax when the exemption sunsets. Therefore, this may be a limited time opportunity.
For example, you can make a gift now and claim it against your lifetime exemption by filing a gift tax return, even though there is no gift tax due.
The estate tax is imposed on an estate nine months after a person’s date of death on assets in excess of the exemption, with a current maximum tax rate of 40%. This tax has been dubbed the “death tax,” more accurately describing what it is and when it is incurred.
Annual Gift Exclusion
In addition to using your federal estate and gift tax exemption, consider taking advantage of your annual gift exclusion. This allows every person to give each recipient up to $15,000 annually with no federal gift tax consequences. Additionally, you can make direct payments for an individual’s medical and tuition expenses. This exclusion is effectively double for joint gifts made by a married couple. Many individuals with large estates utilize this exclusion for gifts to children and their children’s spouses and grandchildren. For example, if you have two children, you and your spouse can give each of them a joint gift of $30,000 annually.
Illinois Estate Tax
Most states have eliminated imposing a state estate tax or inheritance tax. Currently, only 17 states plus the District of Columbia are continuing to levy a tax. Not surprisingly, Illinois is one of them. The Illinois estate tax exemption is $4 million per person, with tax levied on assets in excess of this amount. The estate is responsible for paying any estate tax due. In states with an inheritance tax, the beneficiary is responsible for paying the tax.
As recently as 1997, the federal estate and gift tax exemption was only $600,000. With the exemption now at a record high of $11.7 million, scheduled to sunset on Dec. 31, 2025 and possibly being reduced to $3.5 million under the Biden administration, our conclusion is that the exemption amount will always be in play, with the estate tax as a source of revenue. If your estate value exceeds the federal estate exemption or your state estate exemption, you are wise to consider alternatives for making gifts of assets to remove them from your taxable estate.
Seeking guidance now from your estate attorney and financial advisor may equip you with information to make informed decisions to benefit your heirs, before the sunset.
This is intended for educational purposes only and should not be construed as personalized tax or financial advice. Please consult your tax and financial professional(s) regarding your unique situation.