Updated April 2018: March 2018, the IRS published the final lifetime exemption and Generation Skipping Transfer exclusion amounts for 2018 of $11,180,000. We previously shared $11,200,000 as a preliminary figure. The change results from the IRS’s adoption of “Chained CPI.” Read more in the article Chained CPI Explained and the Impact on the New Tax Act.
The Tax Cut and Jobs Act of 2017, 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.)
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.
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.
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.)
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.