In December 2017 President Donald J. Trump signed into law the Tax Cuts and Jobs Act (the “TCJA”). Among other provisions, the TCJA doubled the federal estate and gift tax exemption amount from $5 million to $10 million, adjusted for inflation. For example, for 2020 the federal estate and gift tax exemption is $11,580,000.
However, the doubling of the federal estate and gift tax exemption is scheduled to sunset on December 31, 2025, and revert back to the previous $5 million exemption, adjusted for inflation. What this means is that if someone were to die on December 31, 2025 with $10 million in total assets, no federal estate tax would be due, because their estate would be under the exemption amount ($10 million adjusted for inflation), but if someone were to die on January 1, 2026 with $10 million in assets, a federal estate tax would likely be due, because their estate would be over the exemption amount ($5 million adjusted for inflation).
The federal estate and gift tax credit is a unified credit, meaning, the credit applies to gifts made during life and your total assets at death. So, if you make no gifts during your life, at your death you have your full credit remaining to apply against your assets. On the other hand, if you make $5 million in gifts during your life, the $5 million is deducted from your credit and you have less credit to apply against your assets at death. After the passage of the TCJA many wealthy individuals and their advisors were concerned about what would happen if someone used the full estate and gift tax credit before the sunset and then died after the sunset. For example, if someone gifted $8 million on December 31, 2025, they would not owe any gift tax on the gift and would use $8 million of their federal estate and gift tax credit. If that person then died the next week on January 3, 2026 (after the sunset of the doubling of the estate tax exemption), when their executor went to file their estate tax return they would show $8 million of lifetime gifts, but only have an approximately $5 million (adjusted for inflation) federal estate and gift tax credit. Therefore, the fear was that tax would be owed on the $3 million balance. The federal estate and gift tax rate is 40%. So, approximately $1.2 million in tax would be due. Practitioners were referring to this as the federal estate and gift tax “claw back.”
However, on November 26, 2019, the Treasury Department and the IRS issued final regulations under IR-2019-189, which basically state that if a taxpayer were to use the full estate and gift tax exemption amount prior to the sunset, there will be no claw back. The regulations provide a special rule that allows estates to use the exemption amount that was applied to gifts made prior to January 1, 2026 or the current exemption amount. What this means is that if a taxpayer makes a gift in 2020 of $11,580,000 (the exact federal estate and gift tax exemption for 2020) and then dies in 2026, the taxpayer’s estate can choose to use the federal estate and gift tax exemption applicable in 2020, when the gift was made, rather than the 2026 federal estate and gift tax exemption amount. This allows taxpayers to make use of the full doubled exemption amount prior to the sunset of the doubled exemption amount at the end of 2025, without fear of a claw back upon their passing. However, this is a “use it or lose it” situation, in that if gifts are not made prior to 2026, then the taxpayer will lose out on using the increased federal estate and gift tax exemption amount.
The federal estate and gift tax exemption is individual, so married couples essentially have double the exemption, in which to transfer their assets. Upon the death of the first spouse to die, the estate tax credit of the deceased spouse is portable, if the surviving spouse files a timely estate tax return and elects for portability. Portability means that if your spouse dies only using half of the federal estate and gift tax credit, then you can have the remaining half of their federal estate and gift tax credit. This is referred to as the deceased spousal unused exclusion (“DSUE”). With the TCJA doubling of the federal estate and gift tax exemption, this begged the question, what happens if a spouse dies in 2024, having used none of their credit and their surviving spouse elects portability, and then dies in 2026? Does the surviving spouse get the full doubled credit or does their portability amount decrease to current levels?
The final regulations under IR-2019-189, answered this question by stating that if a taxpayer’s spouse dies during the period of the higher federal estate and gift tax exemption (2018-2025) and the taxpayer dies after 2026, when the federal estate and gift tax exemption is lower, then the taxpayer may use their full DSUE amount. This allows taxpayers who lose their spouse when the exemption is higher to make full use of their spouse’s exemption.
As I set out in my article entitled, “Estate Planning Opportunities With the Tax Cuts and Jobs Act”, many opportunities exist for high net worth individuals to make use of the doubled estate and gift tax exemption prior to the scheduled sunset in 2026. The estate planning attorneys at Twomey, Latham, Shea, Kelley, Dubin & Quartararo are available at your convenience to answer your questions, review your current estate plan to ensure it continues to meet your needs or to discuss the implementation of an estate and succession plan.
