Rise (and Sunset) in the Estate Tax Exemption
By Joseph Ferrucci
January 2, 2018
On December 22, 2017, President Trump signed the “Tax Cuts and Jobs Act.” The Act primarily changes aspects of the federal income tax. But it also includes an important change to the estate tax: the estate tax exemption has been doubled. In a departure from the prior House and Senate bills, however, this higher exemption level will sunset at the end of 2025. (1)
- Under prior law, the estate tax exemption was set at $5 million per person in 2011. Under the new law, the 2011 base exemption has been increased to $10 million effective January 1, 2018. With inflation adjustments, the actual exemption in tax year 2018 will be $11.2 million per person, and $22.4 million for a married couple.
- The increase in the estate tax exemption also establishes a higher gift tax exemption, because the exemption functions as a “unified credit.” Lifetime gifts in excess of the annual exclusion amount (which has increased to $15,000 as of January 1st) use up some of the giftor’s exemption and thereby reduces the exemption available at death. The Act also has the result of increasing the generation skipping transfer (“GST”) tax exemption to the new higher level.
- On January 1, 2026, the exemption level will revert to what it was under prior law, i.e., $5 million per person in the 2011 base year with annual inflation adjustments, unless a future Congress changes the law again before then.
The sunset provision will seem like déjà vu for taxpayers who recall the changes in the estate tax that occurred during the tenures of President George W. Bush and President Barack Obama. The 2001 increase in the estate tax exemption was scheduled to sunset in 2011. Another exemption increase was passed in late 2010 but was scheduled to sunset in 2013. A third law was passed in early 2013 that finally made the $5 million exemption permanent. (2) The 2013 Act, for the first time in more than a decade, provided a stable and permanent exemption level which created more certainty in estate tax planning.
As it turns out, the $5 million exemption was stable for only a few years until now. The recurring changes in the estate tax exemption, and the use of sunset clauses, reflects the fact that the estate tax has become a highly politicized issue. Elected officials have used the exemption increases and sunset clauses to strike compromises (between those who want to eliminate, and those who want to maintain, the estate tax) and to generate budgetary forecasts that help their various positions.
Nevertheless, the clear trend over the last 20 years, of course, has been a large increase in the estate tax exemption and a substantial reduction in the estate tax. This trend shows no sign of abating. So far, each time a sunset has been imminent, Congress has stepped in to change the law. In all likelihood, there will be a push from some political leaders to extend the higher exemption level or repeal the estate tax altogether before 2026. At least for the time being, we know that the estate tax exemption will remain high. What are the implications for estate planning?
- Make use of the new, higher exemption. For people with larger estates, the higher exemption creates a significant opportunity to transfer wealth during life and at death with relatively low tax impact, and without needing complex estate tax planning. People with larger estates may be able to simplify older estate plans. Bypass or “credit shelter” trusts, irrevocable life insurance trusts, charitable lead or remainder trusts, grantor retained annuity trusts, GST exemption trusts, and other complex estate tax reduction tools may no longer be necessary. Simplifying the estate plan can reduce the hassle and cost of estate plan administration after death.
- Have a backup plan. The reversion to a $5 million exemption will occur on schedule on January 1, 2026 if Congress does not act. If you are younger than 75 and in relatively good health, there is good chance you will outlive the sunset date. Therefore, while taking advantage of the new, higher exemption level, you should have a backup plan for the possible reversion to the $5 million (plus inflation) exemption amount. At a minimum, if you design your estate plan around the higher exemption, plan on contacting your estate planning attorney for an update in 2025.
- Consider gifting. Before the higher exemption sunsets in eight years, you may want to consider gifting assets to beneficiaries, whether outright or in trust. Proceed with caution, however. There are obvious drawbacks to gifting large assets. Gifting requires the irrevocable loss of use and control over assets during lifetime. Also, the Act is not entirely clear about how the use of the exemption for gifting will be reconciled with a lower exemption at death in 2026 and beyond. For example, if an individual has a $14 million estate, makes $8 million of lifetime gifts in 2020, and then dies in 2028 when the exemption has dropped back down to $5 million, what, if any, exemption will be available at death? Will the federal government “clawback” the portion of the lifetime gifts in excess of the exemption level available at death? The Act directs the Secretary of the Treasury to issue regulations to address the issue.
- Keep it in perspective. Even if the law reverts to the lower exemption in 2026, keep in mind that a $5 million exemption is still relatively high from a historical perspective. Since January 1, 2011, under the $5 million exemption level, very few estates have had to file an estate tax return or pay any estate tax. If reversion occurs in 2026, the estate tax again would be expected to affect very few estates. If your estate is less than $5 million in value, the 2026 reversion should have little, if any, impact.
Given the political volatility of the issue, the estate tax will likely change again before long. What we do not know is whether and how things will change. Will the estate tax be repealed altogether? Or, in a new political climate, will Congress allow the higher exemption to sunset or even return to the lower exemption levels of the 1990s and early 2000s? Look out for more change in the estate tax in the coming years. A new law could warrant an estate plan update again at the time.
To consider how new estate tax exemption affects your estate planning, contact your estate planning attorney.
(1) The bill passed by the House of Representatives on November 16, 2017 included a doubling of the estate tax exemption for 2018 through 2024, with a full repeal of the estate tax as of January 1, 2015. The Senate bill, which was passed on December 2, 2017, also doubled the exemption, but it did not repeal the estate tax altogether. In the Senate version, the estate tax exemption remained at the higher exemption level even after 2024.
(2) In 2001, under the “Economic Growth and Tax Relief Reconciliation Act,” the estate tax exemption was increased incrementally from $675,000 in 2001 to $3.5 million in 2009, followed by full repeal of the estate tax for one year in 2010 (during which year there were significant changes to the capital gains basis step-up at death), followed by a sunset and reversion to a $1 million exemption in 2011. In late 2010, before the 2011 reversion took effect, the law was changed again. Under the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act,” the exemption was increased to $5 million plus inflation adjustments, but with a two-year sunset and, again, a reversion to a $1 million exemption. Finally, in the early days of 2013, under the “American Taxpayer Relief Act,” the $5 million exemption level was made permanent.
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© 2018 Joseph Ferrucci, Attorney at Law P.C.