Estate tax planning for uncertain times
The golden age of gifting
Stuart C. Bear, Esq., Ryan Prochaska, JD and Erica J. Lindquist, Esq., CPA, Chestnut Cambronne PA | December 2022/January 2023 Footnote
Editor's note: Updated November 29, 2022
“Opportunities are like sunrises. If you wait too long, you miss them.” — William Arthur Ward
On Dec. 22, 2017, the Tax Cuts and Jobs Act (the Act) doubled the basic exclusion amount (BEA) for federal estate, gift and generation skipping taxes from $5 million per person to $10 million per person. This amount is indexed each year for inflation.
For the year 2023, the BEA for individuals is $12.92 million (this amount is doubled for married couples). Therefore, an individual can gift assets during their lifetime and at death totaling $12.92 million and pay zero federal estate tax. Any amounts gifted in excess of the BEA are taxed at a 40% rate. There is an unlimited marital deduction for assets transferred to a surviving spouse or to a trust for the benefit of a surviving spouse.
The BEA will continue to increase annually with inflation until Jan. 1, 2026, when it reverts to $5 million per person, indexed for inflation. It is estimated the BEA for 2026 will be between $6.5 million and $7 million per person. Those individuals or married couples with larger estates who take this opportunity to make large lifetime gifts prior to 2026 can greatly reduce the amount of federal estate tax due at death.
Anti-clawback regulations
On Nov. 20, 2018, the Internal Revenue Service (IRS) announced that individuals taking advantage of the increased BEAs in effect from 2018–25 would not be adversely impacted after 2025 when the exclusion amount is scheduled to drop to the pre-2018 level.
1 The anti-clawback regulations, codified in Treasury Regulations Section 20.2010-1(c), allow an estate to use the higher of the BEA for lifetime completed gifts or the BEA applicable on the date of death.
Gifting for single individuals
To take advantage of the increased BEA, an individual must make a lifetime taxable gift prior to Jan. 1, 2026, of more than the reverted BEA value. The gift can be made outright to a third party or to a trust for their benefit.
For example, in December 2022, a single individual with a net worth of $11 million — who is excited to be part of the “golden age of gifting” — gifts their entire $11 million estate outright to their only child without consulting their attorney or accountant. On Jan. 1, 2026, the individual dies and the BEA is $6.5 million. Because the individual gifted assets when the BEA was $11 million, the anti-clawback rules apply and no estate tax is due.
If the individual instead gifted an amount less than or equal to the BEA applicable on the date of death ($6.5 million in this example), there would be no estate tax savings. For example, if the individual gifted $5 million in December 2022, their BEA would be $6.5 million. Upon the individual’s death, an additional $1.5 million would be exempt from estate tax ($6.5 million - $5 million (lifetime gift)). Therefore, the amount of estate tax due is $1.8 million (($11 million - $6.5 million) x .40).
Gifting for married couples
When making gifts to individuals, married couples should consider not splitting their gift. Gift splitting allows a married couple to split the value of a gift between them. For example, a married couple with an estate of $15 million gifts $10 million to their children. If the gift is split, each spouse is considered to have gifted $5 million. If the BEA is $6.5 million at the death of each spouse, each spouse can only exclude an additional $1.5 million. If, however, the gift was not split, one spouse’s BEA would be $10 million and the second spouse’s BEA would be $6.5 million, and there is a potential that no federal estate tax would be due.
In addition to gifting assets to third parties, married couples can consider using Spousal Lifetime Access Trusts (SLATs) to make larger gifts between themselves. A SLAT is an irrevocable trust where one spouse (the donor spouse) transfers assets in trust for the benefit of the other spouse (the beneficiary spouse). In order to take advantage of the increased BEA, the amount gifted to the SLAT needs to be greater than the BEA at death. When properly drafted, he initial assets and future appreciation are excluded from the donor spouse’s estate and the beneficiary spouse’s estate. Because a gift to a SLAT is not subject to the unlimited marital deduction, if the gift exceeds an individual’s available BEA, a gift tax is due.
A common strategy is for each spouse to create a SLAT for the benefit of the other. When doing so, it is important to avoid the reciprocal trust doctrine. If the trusts fail the reciprocal trust doctrine, assets within the trusts are includable in the grantor’s estate. To avoid the reciprocal trust doctrine, the terms of the trusts should vary. Such variations include the date of the trust, the amount gifted to the trust, the income distribution standards, the principal distribution standards and the use of a special power of appointment.
For example, a married couple with a combined estate of $30 million implements SLATs to reduce estate taxes:
- Dec. 1, 2022: Spouse No. 1 transfers $12 million to SLAT 1 for benefit of spouse No. 2.
- July 1, 2023: Spouse No. 2 transfers $11 million to SLAT 2 for benefit of spouse No. 1.
- Jan. 1, 2026: Spouse No. 1 dies. Assume the BEA for 2026 is $6.5 million. All of spouse No. 1’s estate transferred to spouse No. 2 upon the death of spouse No. 1.
- Jan. 1, 2027: Spouse No. 2 dies with estate valued at $7 million. Assume the BEA for 2027 is $6.8 million.
Spouse No. 1’s BEA is $12 million and spouse No. 2’s BEA is $11 million. The amount of estate tax due upon spouse No. 2’s death is $2.8 million (($30 million - $12 million - $11 million) x .40). If the married couple had not implemented SLATs, spouse No. 1’s BEA would have been $6.5 million and spouse No. 2’s BEA would have been $6.8 million. The amount of estate tax due upon spouse No. 2’s death would have been $6.68 million (($30 million - $6.5 million - $6.8 million) x .40).
Therefore, by implementing the SLATs, the married couple was able to save $3.88 million in federal estate taxes.
Other gifting strategies
When considering making gifts, there are other strategies that can be used to effectively reduce potential estate tax liability. The 2023 annual exclusion amount is $17,000 per donee (doubled to $34,000 for a married couple). The annual amount gifted with no reduction of an individual’s BEA can be significant. For example, an individual can make a gift of the annual exclusion amount in 2023 to each of his three children and six grandchildren totaling $153,000 with no effect on his BEA.
An individual could also make gifts to an educational 529 plan for a child, grandchild or other school-aged individual. An election can be made to frontload gifts making the equivalent of five years of annual exclusion gifts in one calendar year. For example, in January 2023, an individual can make a one-time contribution to a 529 plan account of five times the annual gift exclusion for each of his six grandchildren ($85,000 each times six grandchildren totaling $510,000). This amount will not reduce the individual’s lifetime BEA. It should be noted that any additional gifts to any of the six grandchildren within five years of the election will reduce the individual’s BEA to the extent they are not covered by an increase in the annual exclusion amount.
Time is of the essence
For certain individuals, there is a significant opportunity to reduce or eliminate federal estate taxes with increased gifting. However, this gifting must be done prior to Jan. 1, 2026, under current law, or this opportunity will be lost.
Stuart C. Bear is a partner, shareholder and the president of Chestnut Cambronne in Minneapolis. He is a fellow of the American College of Trust and Estate Counsel and a member of The International Academy of Estate and Trust Law and the National Academy of Elder Law Attorneys. He also teaches courses on wills and estates as an adjunct professor at the University of St. Thomas.
Ryan M. Prochaska is a partner at Chestnut Cambronne in Minneapolis and practices in the areas of estate planning, estate and trust administration, asset protection planning and cabin succession planning.
Erica J. Lindquist is a partner at Chestnut Cambronne in Minneapolis and practices in the areas of estate planning, estate and trust administration, and tax. She is also an active CPA specializing in estate, trust, gift, and individual tax return preparation.
1 “Treasury, IRS: Making large gifts now won’t harm estates after 2025.” IR-2018-229 (Nov. 20, 2018), available at https://www.irs.gov/newsroom/treasury-irs-making-large-gifts-now-wont-harm-estates-after-2025.
