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Helping Clients Plan for Maximum Use of the Transfer Tax Exemptions


Estate planning entails such rudimentary concepts as having documents in place, having family discussions about testamentary dispositions and bringing in the skill sets of advisors. 

Aug 17th 2020
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There are still clients who may well have issues of actually incurring gift or estate tax. Transfers to grandchildren may also be an issue, but generation-skipping, the GST tax, is not our focus here. If transfer taxes are an issue, there is also the annual gifting concept – taking advantage of the $15,000 annual gift tax exclusion for gifts of present interests. 

The $15,000 figure is the amount as indexed in 2020. If the transfers are sheltered by the annual gift tax exclusion, they do not reduce the unified credit available against lifetime transfers (the gift tax) and those at death (the estate tax).

The 2017 Tax Cuts and Jobs Act doubled the transfer tax exemption, but only through 2025. So in planning, keep in mind the gift and estate tax systems entail a unified credit, or equivalent exemption, available to offset current transfers, later transfers prior to death and transfers at death.  

There’s also the question for the tax planner – has the client made gifts in the past such that the full exemption isn’t actually available in 2020? It is quite common to not file gift tax returns even though some level of past gifts may have absorbed some of the exemption.  

Has the client filed gift tax returns in the past?  Has the client made major gifts in the past without filing gift tax returns?  In beginning our tax planning today, the first question is usually how much exemption is left?

The second question may focus on the prospects of increased wealth. Is there any realistic prospect that the client’s wealth will be subject to transfer tax that isn’t covered by the unified exemption?

First, here’s a brief note about the prospects of change. As we write in August, 2020, the presidential election is only a few months away. Should Mr. Biden win, there is some suggestion the transfer tax exemption will be cut back sooner than 2026, even in 2022.   

The proposals associated with Mr. Biden also include the possibility that the familiar income tax planning tool of holding appreciated property till death could go away or be limited. There is the prospect of carryover basis as a general income tax rule, which also suggests keeping old cost records and tax returns because these may be necessary to establish tax basis.

So, there is the scheduled reduction in the exemption in 2026, plus the possibility of near-term reduction in the exemption. This author has not read suggestions of an increase in the exemption within the Trump camp nor an impetus in the near term to even repeal the estate tax. In general, in this author’s view and readings, one would not at this point plan on gift and estate taxes becoming less of a planning issue. 

In 2020, a person’s unified exemption is $11,580,000. This is basically the “old” $5 million exemption plus the $5 million increase in the exemption that arose in 2018 with the 2017 Tax Cuts and Jobs Act, plus indexing.

This means the couple’s combined exemptions in 2020 are $23,160,000. We note that transfers between spouses are generally subject to an unlimited gift tax marital deduction or unlimited estate tax marital deduction. The indexing can generally be expected to increase the exemption somewhat each year, but one can only project (guess at) the measure of the exemption after 2020.

What happens if the couple make lifetime gifts to children that absorb their current high level of  exemptions, then there’s an estate tax return in, say, 2026?  One way to conceptualize our question would be to distinguish the incremental $5 million of exemption arising in the 2017 Tax Act and ask if its use in 2018-2025 “turns around” to trigger estate tax after 2025?  The IRS took the leadership here, resolving that use of the higher exemption in pre-2026 isn’t added back in figuring the post-2025 estate tax.

The IRS explains as follows regarding the basic exclusion amount (BEA): 

 “To address concerns expressed by a number of stakeholders, the proposed regulations clarify that people taking advantage of the increased BEA by making gifts during the period 2018 to 2025 will not be harmed after 2025 when this amount is scheduled to drop. The regulations provide a special rule that effectively allows the estate to compute its estate tax credit using the greater of the BEA applicable to gifts made during life, or the BEA applicable on the date of death.  As a result, people planning to make large gifts between 2018 and 2025 can do so without being concerned that they will lose the tax benefit of the higher exclusion level once it decreases.” 

What if one spouse passes in say 2020 and the survivor passes in 2026 considering the scheduled scaling back of the exemption? Assuming there are no further tax law changes, the exemption of the surviving spouse would reflect the $5 million as indexed in 2026. However, assuming portability and no use of the predeceasing spouse’s exemption in 2020 or earlier, the exemption available under portability in the surviving spouse’s estate would be increased by the full $11,580,000.

So, there is a range of possible exemptions to our couple. We close in noting the IRS commenting on electing portability. The context even suggests the importance of portability:

“In order to elect portability of the decedent's unused exclusion amount (deceased spousal unused exclusion (DSUE) amount) for the benefit of the surviving spouse, the estate's representative must file an estate tax return (Form 706) and the return must be filed timely. The due date of the estate tax return is nine months after the decedent's date of death, however, the estate's representative may request an extension of time to file the return for up to six months. An automatic six month extension of time to file the return is available to all estates, including those filing solely to elect portability, by filing Form 4768 on or before the due date of the estate tax return.”