The Estate and Gift Tax Exemption – What We Know, What We Don’t, and What You Can Do
THE COUNSELOR
Volume 11 • Issue 2 • February 2021
The Counselor is a newsletter of Hallock & Hallock dedicated to providing useful information on estate planning and business planning issues. This month's issue will discuss the estate and gift tax exemption. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
Back in November we wrote about possible ramifications from the 2020 election. At that time, many things were in doubt. While the results are now clear, the estate tax and gift tax law continues to be in flux. The gift tax is a tax on transfers of money or property to other people while getting less than full value in return. The gift tax only applies to gifts that exceed $15,000 to a single person in a single year. The lifetime gift tax exemption is the amount of taxable gifts a person can give away over his/her lifetime to any number of people without paying a gift tax.
The estate tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have an interest in at the date of death. This may consist of cash, securities, real estate, insurance, trusts, annuities, business interests and other assets. The total of all of these items is your "Gross Estate." Once you have determined the Gross Estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at your "Taxable Estate." These deductions may include mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The value of some operating business interests or farms may be reduced for estates that qualify. After determining the Taxable Estate, taxable gifts that were given during your lifetime and not subject to taxation because of the lifetime gift tax exemption (beginning with gifts in 1977) are added to this number. So, if the Taxable Estate is $10 million, but taxable gifts of $2 million where given away during your lifetime, the actual Taxable Estate is $12 million.
If you are not confused yet, this is where it really gets confusing. Most estates are not large enough to require the filing of an estate tax return and the payment of taxes. However, a filing is required and taxes will be owed for estates when the Taxable Estate after adding in lifetime taxable gifts exceeds the applicable estate tax exemption amount for the year of death. In 2010, Congress set the estate, gift, and generation-skipping transfer (GST) tax exemption amount at $5 million per individual ($10 million per married couple), adjusted each year for inflation. In 2017, legislation temporarily doubled the exemption amounts to $10 million per individual ($20 million per married couple). As indicated, the 2017 legislation is temporary. If nothing has been done to extend or make permanent the 2017 law by December 31, 2025 the exemption amounts will revert back to the amount under the 2010 law. In 2021, an individual may make $11.7 million, and a married couple may make $23.4 million, in lifetime or testamentary (at death) transfers without being subject to the 40% wealth transfer tax. Are you confused yet? If not, add into the mix that certain tax reform proposals being floated are seeking to reduce the exemption to the pre-2010 level of $3.5 million per individual.
So, going forward we have three possible scenarios:
The current exemption amount ($10 million per individual indexed for inflation) is extended or made permanent prior to December 31, 2025;
The current exemption amount expires and we revert to the 2010 exemption level ($5 million per individual indexed for inflation) on January 1, 2026; or
Tax reform happens sooner and the exemption amount is potentially reduced to as little as $3.5 million per individual.
Let’s assume that a married couple has a Taxable Estate with a value of $13 million at the death of the surviving spouse. Under current law, with an exemption of $23.4 million, no estate tax would be due. However, if the death occurs in 2026 and the exemption has reduced, it’s “Houston we have a problem.” Assuming inflation adjustments puts the exemption at $6 million per individual ($12 million for a couple), there would be $1 million subject to estate tax at 40% or $400,000 due and payable within nine months of the date of death. Obviously, things get worse if the exemption is reduced to $3.5 million per individual, especially if the projected increase in the tax rate to 45% occurs. In this scenario, the estate tax owed increases to $2.7 million (45% of $6 million).
While it is difficult to say how this will all play out, it seems likely that either options 2 or 3 above are the most likely outcomes at this point. Even though we do not know for sure, there are a few things you can do to prepare now.
If a married individual passes away and the taxable estate is anywhere near $3.5 million, the surviving spouse should absolutely file an estate tax return to preserve the deceased spouse’s exemption. This is called portability and will allow the surviving spouse to retain that additional exemption amount in addition to their own.
If the estate is valued at appreciably less than that amount, but the surviving spouse is quite young or the assets are highly appreciating, serious consideration should be given to filing for portability anyway. Remember, it cannot hurt and it may be the best decision you ever made.
If you as an individual have an estate nearing $6 million (or a married couple nearing $12 million) you should probably begin planning to use your exemption before it either expires or tax reform occurs. That may mean as soon as this year.
If you would like to read more about some of the strategies that might be employed in using your exemption before it expires take a look at our November 2020 newsletter. These are complicated decisions. As you can see, it quickly becomes very confusing and the planning options are many. Therefore, competent counsel should be involved in helping you make these decisions. The good news is there are things that can be done to avoid this tax. But only if you prepare. At Hallock & Hallock, we’re prepared to help you prepare.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.