Adapt Your Gifting Strategy Ahead of Potential Estate Tax Changes

by Matt Hisey and Rick Spires

With the Biden administration well underway and Democrats leading both houses of Congress, the possibility of a reduction in the estate and gift tax exemption looms on the horizon. Numerous proposals are floating around Washington, different in their details but all intent on lowering the estate tax exemption from its current level. Will it happen? The crystal ball is hazy. Still, adopting a proactive stance now is only prudent in case it does become the reality.

Big changes could be on the way
A new administration always brings the potential for significant changes to the tax landscape, and 2020 offered an especially stark contrast between two opposing taxation paradigms. The Tax Cuts and Jobs Act of 2017 increased the estate tax exemption dramatically, along with expanding gift and generation-skipping exemptions.

The estate exemption is currently inflation-indexed and allows $11.7 million net taxable value to pass untaxed to non-spouse estate beneficiaries, with full step-up in basis for assets included in the estate. (The $11.7 million is a lifetime exemption, so that cap is reduced by the amount of any gifts above the annual tax-free limit – currently $15,000 – made while the donor is still alive.)

Originally set to sunset at the end of 2025, with the expectation that Congress would extend the policy, those generous rules may be more short-lived than planned. Even if they do remain intact until the sunset date, it’s quite possible that they will not be extended beyond that time. At that point, the estate tax would drop to $5.49 million (adjusted for inflation) in 2025.

Either way, taxpayers with significant assets should understand the changes that may be coming and take steps now to minimize their potential impact.

  • Proposals circulating in Congress with some support suggest dropping the exemption to somewhere between $3 million and $5 million.
  • There’s also a strong possibility for any new tax legislation to eliminate the step-up basis for inherited assets.
  • Assets subject to the estate tax may be taxed at a rate of 40% or more – one bill suggests starting at 45% and increasing the rate to 65% for certain estates!

Act while generous estate tax exemptions remain

A drastically lowered estate tax exemption would have a big impact on those with net worth of $5 million or more, and such an event is entirely within the realm of possibility. The good news is that it’s not very likely that any tax bill implemented in the next few years will incorporate a clawback clause for previous gifts. Taken together, those facts make clear that now is the time for action.

The most advantageous strategy for individuals and families that may be impacted by the estate tax is to compress giving as much as possible, pushing gifting into this year with any amount of the exemption that is still available for use. By taking advantage of the more generous limits in place in 2021, these taxpayers can create dramatic tax savings.

Establishing or fully funding an existing irrevocable trust may also be appropriate for some taxpayers. This strategy allows grantors to transfer assets to the trust now using the current $11.7 million limit, after which the assets can continue to grow outside of the estate. Including appreciated assets in the trust also safeguards them against potential capital gains taxes should the step-up rules change.  

Each situation is different, of course, so it is imperative that you work with a knowledgeable professional to create and implement a customized, tax-efficient gifting strategy. Whatever the strategy, though, it’s better to be informed and act while there’s still time than to hide your head in the sand about the changes that may come to pass. Reach out to your Mauldin & Jenkins tax advisor to learn more.