Is Now the Time to Use Your Lifetime Exemption?

Many clients are asking about how to plan in light of possible changes to the federal estate tax law. In response to current events and the impact on state and federal budgets, it is very possible that the federal estate tax exemption could be reduced from the current amount of $11,580,000 per person (effectively $23,160,000 per couple). Part of the uncertainty is that more extensive changes could be enacted, such as an inheritance tax, carryover basis or capital gains at death, or increases in the Washington or Oregon estate taxes (or other states adding state estate taxes). Planning for income taxes will likely continue to be a concern, and states may be adding or increasing state income taxes as a result of budgetary shortfalls.

One strategy that emerges from these concerns is the importance of lifetime gifts to children or other family members, in order to use some or all of the federal estate tax exemption during lifetime.

What are the advantages to making a large gift now?

If you plan to give your estate to children or grandchildren or other individuals at your death, there can be advantages to larger lifetime gifts. Every U.S. taxpayer can make an annual gift of $15,000 per recipient and can pay the medical or educational expenses of others as long as those expenses are paid directly to the medical or educational provider – those are excluded gifts. Gifts that are larger than those limits use up your federal lifetime exemption, resulting in less exemption remaining at death. So, if for example you make your first larger gift this year, and it exceeds the excluded gift amounts by $2 million, you will have $9.58 million in exemption if you die later this year, but before any laws change. (If Congress does nothing, the federal exemption of $11.58 million will continue to be indexed up by inflation.)

The advantage of making such a larger gift is that the appreciation will not be taxed in your federal estate and will be shifted to the recipients. Also, if you live in Oregon or Washington, your estate will not pay those states’ estate tax on those gifts. (Oregon and Washington only tax what you own at death, and do not adjust the exemption for lifetime gifts. Oregon’s exemption at death is $1 million and Washington’s is currently $2,193,000.)

If you are able to make a gift larger than what the federal exemption may be in the future, a larger gift may also provide advantages. For example, if the federal exemption was $5 million and it falls to $1 million, and you were able to make a gift of $5 million, you would have avoided estate or gift tax on the amount you gave over the new exemption of $1 million.

What if the federal exemption is lowered? Will I owe any tax or otherwise have my gift “clawed back”?

On November 26, 2019, the Treasury Department and the IRS issued final regulations under IR-2019-189 confirming that there will be no “clawback” for gifts made under the increased estate and gift tax exclusion put in place by the Tax Cuts and Jobs Act of 2017.

Are there downsides to making a large gift?

In thinking about making a larger gift, one major consideration is the amount of assets to retaint to maintain your lifestyle, which may affect which types of assets you wish give away. Perhaps certain assets provide you with a stream of income or have some other benefit you would like to continue to control.

Another major consideration is asset basis and built in capital gain. When you make a gift, the recipient does not pay any tax upon receiving the gift. But he or she does take on your basis and may pay capital gains tax if the assets are subsequently sold. As a result, the best assets to give are cash, other assets with a high basis, or assets that your recipient is very unlikely to sell. We are available to help you evaluate which assets might be most advantageous for you to gift, taking into account your particular circumstances.

Are there other considerations?

We recently sent a client alert about the types of gifts that are best suited to a low interest rate environment, such as GRATs, installment sales, intrafamily loans, and charitable lead trusts. We would be happy to provide additional information tailored to your situation on those sorts of gifts.

When making larger gifts, some clients would like it held in a generation-skipping or other long running trust, to prevent beneficiaries from access at too young an age, to provide the beneficiaries with some creditor or divorce protection, or to locate the assets with a corporate trustee in a favorable jurisdiction for income tax or other trust laws. If you are thinking of making a gift of a family residence or vacation property, there are some special trusts or other arrangements that you might consider. We can also provide more information about those considerations.