The $6 Million Client Needs Your Advice Now on Estate Taxes

Even if Congress doesn’t let the $12.9 million estate-tax exemption lapse in 2026, clients should get their gifting in order today.

By Ilene Slatko
Ilene Slatko
Ilene Slatko

When the Tax Cuts and Jobs Act (TCJA) was passed in 2017, it implemented a number of adjustments to the tax code. Chief among them: reducing tax rates on individuals and businesses, limiting deductions on state and local taxes (SALT) and doubling the estate-tax exemption.

Because the new law provides for an increase commensurate with inflation, in 2023 the lifetime gift and estate-tax exemption will rise to $12.92 million per individual or almost $26 million per couple. This ability to shield assets worth multimillions is quite impactful: The highest tax rate on gifts and estates over the exemption is 40%. Also consider that top federal tax rate on income in 2023 is 37% for couples earning more than $693,750.

However, the TCJI’s gift and estate-tax provisions, as well as other tax rules, will sunset at the end of 2025 unless Congress votes to extend or make them permanent. If allowed to sunset, the lifetime gift and estate-tax exemption will revert back to $5.49 million (the exclusion in 2017) plus an adjustment for inflation. Economists expect the inflation-adjusted number will be approximately $6.2 million in 2025, although some speculate it could be as high as $7 million.

The questions are: How can clients best take advantage of the higher exemption over the next three years? What planning can clients do now to shield the maximum amount should the exemption be allowed to sunset? Most important, what happens if clients implement estate planning now to take advantage of the higher exemption and it sunsets during their lifetime?

Good news

Fortunately, in 2019 the IRS issued a clarification regarding these concerns and it’s good news for clients. The final regulations clarify that people taking advantage of the increased basic exclusion amount (BEA) by making gifts during 2018 to 2025 will not be harmed after 2025 when this amount is scheduled to drop. The regulations provide a special rule that effectively allows the estate to compute its estate-tax credit using the greater of the BEA applicable to gifts made during one’s lifetime, or the BEA applicable on the date of death.

Any gift made during these years since the TCJA was passed will be allowed against the higher exemption in effect during those years. As a result, people planning to make large gifts between 2018 and 2025 can do so without being concerned that they will lose the tax benefit of the higher exclusion level should it decrease.

This currently leaves high-net-worth clients three years to gift assets if they want to shield the allowable maximum. The annual gift exclusion has also increased annually with inflation: In 2023, individuals may gift up to $17,000 to each recipient. Recipients can be anyone – children, parents, siblings, friends, etc.

Additional Reading: Mitigating Inflation Risk for Federal Retirees

Nuts and bolts

Gift and estate taxes apply to transfers of money, property and other assets. Gifts made to children, grandchildren, other family members, or any recipient of their choosing over the next three years, up to the maximum, are free from gift taxes and will reduce the taxable estate. Tax law also allows for any size gift to be made, as long as larger gifts are reported on a gift-tax filing. Because of the unified gift and estate tax exclusion, taxes will generally not be due at the time a gift is made. The gift-tax filings are compiled to later determine the amount of the estate tax exemption that may have been utilized prior to death.

For those high-net-worth clients whose assets are between $6.2 and $12.9 million, these next three years provide an extraordinary opportunity to reduce their estate tax liability. According to the U.S. Census and the Bureau of Labor Statistics, in 2022 there were approximately 6.7 million Americans who qualified as HNW ($1 million – $5 million in assets), and another 700,000 who were UHNW ($5 million – 30 million in assets). Those numbers don’t take any future asset appreciation into account, so it’s probable that those on the margins will find themselves above the basic exclusion amount.

Possible scenarios

Let’s look at three gifting scenarios.

In the first, a client on the margin decides to be proactive and begins to make annual gifts to family members or other recipients in order to keep their taxable estate under the 2026 presumed lower rate. By setting up irrevocable trusts or making outright gifts, they are successful in their goal. And then, Congress decides to extend the BEA. What is the impact? Unfortunately, these gifts have successfully transferred assets out of their pocket to someone else’s. However, if the gifts were in the form of property (deeded or in the form of a trust) the clients could retain liquid assets and maintain their lifestyle.

In the second scenario, the client decides to be proactive, as above, and uses the next three years to make gifts to family and other recipients. This time, however. the BEA gets rolled back (and it should be noted that some members of Congress want to reduce it to $1 million). What are the consequences? To the extent the client has reduced their taxable estate below the BEA prior to sunsetting, they have effectively shielded their estate, regardless of what the exclusion is when they die.

In the last scenario, the client wants to wait to make gifts until the future of the exclusion is more certain. But, drawing up sophisticated estate-planning trusts and funding these vehicles may take some time. For those clients whose estates are currently valued between $6 million and $12.9 million, beginning these conversations with you and other professionals now may be their best first step.

While the future is never certain, finding a strategy to reduce a taxable estate has never been easier. Historically, it is important to remember that the current estate-tax exclusion is the highest it has ever been. With the 2019 IRS clarification, savvy advisors know there are few reasons not to take advantage of the opportunity currently at hand.

llene Slatko, is the CEO and founder DSS Consulting. She spent over 25 years as a financial advisor and built her business through her seminar series, “Women and Their Money.” For the last 10 years, Ilene has focused exclusively on financial education and helping clients build strong financial decision-making skills. She works frequently with women during the long tail of a divorce or an estate and assists them with the administrative and financial choices they face. She is a subject-matter expert on the Federal Employees Retirement System (FERS) and speaks to audiences across the civil-service spectrum.

 

 

Latest news

Prominent Silicon Valley Investors Turn Against Biden

Support for Trump was taboo in the liberal bastion, but frustration with Biden has driven some influential venture capitalists to the right.

Self-directed Brokerage Accounts Continue Growth Spurt

Balances in advisor-led Schwab Personal Choice Retirement accounts maintain a strong lead over non-advised accounts.

Tuesday More Investment Transactions May Fail

U.S. trading moves to a shorter settlement on Tuesday, but it is expected to temporarily increase transaction failure for investors.

State Street Global Advisors Adds SPDR Portfolio Treasury ETF to lineup

Priced at 3 basis points, the new offering provides broad treasury exposure to customize bond portfolios.

Commonwealth Increases Alternative Market Access With iCapital Platform

The new system is targeted to high-net-worth investors but will be expanded to serve individuals of other wealth classes.

2024 ETF Insights for Financial Advisors

The use of active ETFs and model portfolios is rising, according to a Brown Brothers Harriman report.