The Gift That Keeps on Giving!

Leveraging the Increased Estate Tax Exemption Amount

Susan P. Rounds, JD, CPA, LL.M. (taxation), AEP®, TEP

The Federal Estate Tax Exemption Amount Has Been Temporarily Doubled

Most advisors are aware that for 2019, the exemption for combined federal estate and gift tax purposes has been increased for inflation to $11.4 million per person/ $22.8 million per married couple (up from $11.18 per person/$22.36 per married couple in 2018).  The new exemption amount is a result of the 2017 Tax Act, which doubled the previous per person $5 million combined estate/gift-tax free amount (as adjusted annually for inflation).

Unfortunately, the increase is only temporary and is set to expire on 12/31/2025.  Unless there is a change in the tax law, as of 1/1/2026 the federal estate exemption will revert to the original amount of $5 million per person (as adjusted for inflation).  As you may recall, the inflation adjusted 2017 amount was $5,490,000.

Use It or Lose It

Because of the prospective reversion to the previous exemption amount, this could be a “use it or lose it” benefit for taxpayers.   Accordingly, clients may want to consider using the increased exemption amount for gifting purposes before it expires.  To further leverage the gift, consider gifting to a Dynasty Trust sitused in a state that has dramatically increased the length of time before a trust must come to an end, or abolished its “Rule Against Perpetuities” entirely.  In such a state, a properly drafted trust can pass wealth from generation to generation without incurring a transfer tax for as long as the assets remain in the trust.  (Note that proper drafting limits beneficiary control over the assets.)

Other considerations:  Individual state transfer taxes may be implicated on the initial transfer.  Also, income tax may apply to the trust based on several factors, such as the type of investments held within the trust, the state in which the trust is sitused and the state of residence of the beneficiaries.

Leveraging the Gift

Assets held within the dynasty trust and allowed to grow free of a federal generational transfer tax (note the maximum rate is 40%) may vastly increase over time as compared to assets that are not protected against such a tax.  Moreover, if the trust is drafted and sitused properly to avoid unnecessary exposure to state income tax every year, the corpus may increase faster still.  Some states even afford protection for trust assets against potential creditors.

What Happens at Sunset?

Will a grantor who made gifts sheltered by the increased exemption amount be subject to transfer tax if the exemption reverts to previous lower amounts?  The IRS answered this nagging question via Revenue Procedure 2018-57, which provides that there will be no “claw back” if the increased exemption amount is used before 2026.  In other words, gifts that were sheltered by the increased exemption amount from 2018 – 2025 will NOT be pulled back into the estate tax calculation and subjected to estate tax when the grantor dies.

In sum, a strategically drafted and sitused Dynasty Trust may provide a vehicle to leverage the current Estate Tax Exemption Amount by allowing the trust assets to grow generation after generation without exposure to federal transfer tax and possibly even income tax.  From a macro-family balance sheet perspective, this can greatly increase the family wealth.

Happy Reading!

 “Knowledge is weightless, a treasure you can carry easily” – Anonymous

Email me at editor@naepcjournal.org with your comments and suggestions.

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