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New Law Doubles the Estate Tax Exclusion Amount but Only Through 2025

Phillips Bragg
January 2018
by Phillips M. Bragg, AEP®, CFP®

The 2017 Tax Act passed in late December doubled the estate tax exclusion from the expected $5.6 million to $11.2 million in 2018. For couples, the combined available exclusion is now $22.4 million. This provides significant cover from the wealth transfer tax system also known as the Gift and Estate Tax. However, because the law is temporary, planners and taxpayers feel like it's déjà vu all over again.

Back in 2012, faced with the prospect of a shrinking estate tax exclusion in 2013—from $5.12 million to $3.5 million—planners and taxpayers needlessly fretted. In the first week of 2013, the exclusion amount was made permanent, making much of the "panic planning" of 2012 less imperative, if still useful. Oh, to have some of that time back … and fewer gray hairs. Now we are poised to go through it all again on the eve of 2026 when the new exclusion amount is slated to return to $5.6 million. (The exclusion increases with inflation but throughout this article we use the unadjusted amount.)

Here are some relevant questions and answers:

  • What transfers are subject to tax? The gift/estate tax is levied against transfers of wealth to non-spouse, non-charity recipients. Amounts transferred to your spouse or to charity are not subject to transfer tax.
  • How much may I transfer to my non-spouse, non-charity heirs free of the transfer tax? The "Exclusion Amount" is the sum of assets that you may give during your lifetime or leave at death to your heirs without being subject to the 40% transfer tax. At the end of 2017, the exclusion amount was $5.49 million (double that for couples); with the new law and through 2025, the amount is $11.2 million or $22.4 million for couples. The exclusion amount is set to increase with an inflation factor annually.
  • Why is it called a "Unified System"? This means that transfers of wealth are reportable and cumulatively tracked during your lifetime when "gifts" are made, and at your death, when your estate is subject to tax. For example, if you report a gift of $5 million this year and die next year, your estate will have $6.2 million of unused exclusion available.
  • Is there any difference between a transfer of exclusion amounts during lifetime and at death? Yes, lifetime transfers carry the original cost basis to the recipient while transfers at death carry a new basis equal to the fair market value at death to the recipient. This is often called a "step-up" in basis. Thus, an appreciated asset received as a gift has an embedded capital gain liability whereas a transfer from an estate does not. If the asset to be given is cash, then there is no difference between a gift and a transfer at death as long as the amount given doesn't cross the exclusion threshold. (This article does not address the question of taxable transfers–gifts in excess of the exclusion amount.)
  • If the system is unified and "cumulative," and if I would forgo the "step-up" with a lifetime transfer, why would I accelerate the transfers to my heirs? There are a few reasons: 1) You may want them to have the use of the funds sooner than later. 2) You believe you can get the asset out of your estate at a discounted value based on its lack of marketability or control. 3) You believe the assets you are transferring will appreciate and therefore, you will be removing the growth of that asset from your estate.
  • What will they do in DC if they don't make the exclusion permanent? Good question. Presumably, a person who makes transfers exceeding $5.6 million will have successfully removed those dollars from their estate. However, in a worst-case scenario, the cumulative nature of the gift and estate tax could "claw back" those gifted dollars when the person's estate tax is calculated at death. For example: Decedent in 2026 has assets in his estate of $3 million. He reported tax-free gifts in 2025 of $9 million when the exclusion amount was $11.2 million. Is his total estate value on which tax is calculated $12 million with a $5.6 million exclusion or will there be some recognition that the entire $9 million should be offset by the exclusion that existed at the time of the gift? (The bill includes language preventing "Claw-Back" but does not explain how this would be done. If this confused you, join the club and hope the legislative committees solve this fairly.) Also, a related question is what happens to unused exclusion amounts that are "ported" from a decedent's estate to a surviving spouse. Will the survivor's exclusion amount be limited to the amount allowed under the post-2026 law or will it respect the amount of exclusion that went unused when the spouse died prior to 2026? (It may help to follow the link in this paragraph for a refresher on portability of a deceased spouse's unused exclusion.)
  • Does this law affect Generation Skipping Transfers? This article does not explore GST planning specifically. However, in this law, the GST exclusion follows the basic exclusion amount and has therefore doubled, increasing the attractiveness of dynastic wealth transfers.
  • Are my estate planning documents still current? The doubling of the exclusion means that a much different outcome could be in store for estate plans that fund bequests or trusts based on the size of the exclusion. For example, if you are worth $10 million and are leaving your exclusion amount to your children and the balance to your charity, the new law just disinherited your charity whereas before they stood to inherit about $4.4 million! In short, if your estate exceeds $5.6 million, now may be a good time to review your plan.

In light of the myriad considerations above, what should you do? Here are some examples, all of which assume that you can afford to part with some of your assets. For simplicity, we've assumed the taxpayer is single in each scenario. Were he married, the available exclusion would be double and the planning that much more exciting and complex.

Scenario 1
You are likely to die before 2026, have a net worth well over the exclusion amount, and have only highly-appreciated assets. If your children can wait for their inheritance they should because there doesn't appear to be enough time for the assets to grow enough to make up for the lost step-up. For example: You have $11.2 million in stocks with a cost basis of $5.2 million. The embedded gains would be $6 million and the eventual capital gains tax would be about 25% of this or $1.5 million, assuming your heirs are in high tax brackets. For the gift to be more valuable than the step-up in the estate, the $11.2 million would need to appreciate 33%, or $3.75 million, after the gift and before you die. (The 40% estate tax on that growth would equal the $1.5 million.) To be fair, one must consider the possibility that your heirs will not, willy-nilly, liquidate and pay capital gains taxes on their inheritance. Therefore, each family's situation is unique and should be considered.

Scenario 2
You are healthy but have the exact same financial situation as the first character. You too can afford to part with your full exclusion amount. The bogey to beat, 33%, is within reach as time is on your side, so you advance the full gift. Now, in 2026, if the exclusion amount drops back to $5.6 million, you will be pleased that you took full advantage of the small window of time when the exclusion was twice as large … assuming there is no claw-back during the future calculation of your estate tax liability. (See the 3rd to last bullet point above.)

Scenario 3
You have an estate of $8 million and can’t afford to give away more than about $4 million. The estate tax your heirs would have faced under the old law would have been about $960,000 but under today's new exclusion amount, the tax would be zero. That's great news if you are terminally ill but, happily, that's not you! What about 2026, though, when you—or your heirs, to be exact—are faced with that potential estate tax again? This is a quandary. A gift of $5.6 million or less really doesn't take advantage of the new $11.2 million exclusion. You should wait. Wait and watch Washington to see if they are really going to allow the exclusion to drop back to $5.6 million and then, with graying hair, start crunching the numbers in mid-2025 because you might want to do some aggressive gifting in December of 2025.

Important Note: The taxpayer in all three scenarios should consider leveraging the more basic planning tools available such as making annual gifts up to the annual exclusion amount and/or paying tuition needs of children and grandchildren. In addition, there are many "estate freeze techniques" designed to get the future growth out of the taxpayer's estate. The question is whether, in addition to these methods, the taxpayer should also utilize some of his or her exclusion amount.

This would be a good time for me to make a remark about politicians and the state of DC but I'll spare you. Call us if you'd like to discuss your own scenario and the wisest action for you. We look forward to working with you and your counsel, incorporating what we know and considering what we can't know.

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.