The estate and gift tax exemption is the amount that an individual can transfer to another individual tax-free either during lifetime or at death before a 40% transfer tax is imposed.
What is the current estate and gift tax exemption?
In 2017, the Tax Cuts and Jobs Act (TCJA) raised the base amount from $5 million to $10 million per person. The $10 million base is adjusted annually for inflation. The inflation-adjusted exemption amount for 2019 is $11.4 million for 2019 per person. It will increase in 2020 to $11.58 million per person.
The TCJA also doubled the amount of exemption that may be rolled over, or “ported,” from one spouse to another at the death of the first spouse.
What is the TCJA sunset provision?
The increased exemption amount is temporary and scheduled to sunset, or revert, to $5 million per person (adjusted for inflation) as of January 1, 2026.
The sunset provision created a question as to whether gifts of greater than the inflation-adjusted $5 million exemption made between 2018 and 2025 would be subject to estate tax if the donor died after January 1, 2026. Similarly, the sunset provision also created confusion as to whether amounts ported from one spouse to another in excess of the inflation-adjusted $5 million exemption would remain available to the surviving spouse after January 1, 2026.
What will happen under the regulation issued by the IRS?
On November 26, 2019, the Treasury Department and the Internal Revenue Service issued final regulations under IR-2019-189 confirming that individuals who take advantage of the increased gift tax exclusion or portability amounts in effect from 2018 to 2025 will not be adversely impacted when TCJA sunsets on January 1, 2026. This regulation was part of Treasury Decision 9884 which implemented changes made by the TCJA.
How will the estate tax be calculated after December 31, 2025?
The final regulations provide a special rule that allows the estate to compute its estate tax credit using the higher of the basic exclusion amount applied to gifts made prior to January 1, 2026, or the basic exclusion amount applicable on the date of death. A similar special rule applies to an exemption that is “ported” to the surviving spouse.
As a result, individuals planning to make large gifts between 2018 and 2025 can do so without concern that they will lose the tax benefit of the higher exclusion level once it decreases after 2025. Similarly, spouses who have the benefit of additional, “ported” exclusions made in this period will continue to have the benefit of those ported exclusions after 2025.
An example
In application, suppose an individual transfers $10 million into an irrevocable trust in 2020, makes no further gifts, and dies owning $3 million of other, taxable assets after January 1, 2026, when the estate tax exemption has reverted to an inflation-adjusted $5 million. Assume the inflation-adjusted exclusion amount is then $7 million. The estate tax would be calculated with an exclusion amount of $10 million, not $7 million, leaving only the $3 million of remaining assets exposed to estate tax.
The regulations set out a “use it or lose it” benefit. If an individual dies after 2025 and did not make gifts between 2018 and 2025 in excess of the sunsetted exclusion amount in effect at his/her death, the excess exclusion is lost.
Of course, this is a very simple example. Many situations will be much more nuanced. The final regulations provide a window for strategic gift planning that should be discussed with your estate planning attorney.