By Bill Falor
Noland, Hamerly, Etienne & Hoss
As published by Coastal Grower magazine, Fall 2024
Prescient readers of this magazine may already know what’s going to happen at the end of 2025, and for that they have my compliments. More specifically, they may know whether Congress will extend the currently high estate and gift tax exemption amount of about $14,000,000 per person or let it return to its prior level of about $7,000,000.
For those of us who can’t claim clairvoyance, I’ll provide a partial analysis of your estate planning options based on what we know now:
- You have the ability to give away a certain amount of your assets during your life or at your death free of estate or gift tax.
- The amount of assets you’re able to give away (“exemption amount”) changes every year – currently, the number is about $14,000,000, but if Congress doesn’t take action by the end of 2025, this number will automatically decrease in half to about $7,000,000.
- If you make taxable gifts during your lifetime (i.e., you give more than $18,000 to a given person in a given year), you’ll need to report those gifts to the IRS. If in the year of a taxable gift you have cumulatively given away an amount less than the exemption amount for that year (i.e., including that year’s gift and any prior year gifts), then such gift will be free of tax; if, however, you’ve given and are giving away more than your remaining exemption, then you’ll pay roughly 40 cents on the dollar in gift tax.
- Once you die, if you’ve made taxable gifts during your lifetime or otherwise have substantial estate holdings, your executor will report such holdings to the IRS. In reporting these holdings, for purposes of determining whether or not you have any estate tax payable, your executor will add back in your lifetime gifts such that the sum of your estate holdings at your death and your lifetime gifts will be measured against the exemption amount in the year of your death. If that sum exceeds the exemption amount, you’ll pay roughly 40 cents on the dollar in estate tax.
- Crucially, to add a confusing wrinkle, the government does not clawback taxes on gifts which used available exemption amounts when the exemption amount was higher in the year of the gift than the year of death. So, if you made substantial gifts during a high exemption year that exceeded the exemption amount in the year of your death, your estate will not face estate tax with respect to those gifts (i.e., your year-of-death exemption amount is deemed to be equal to the amount of those gifts).
Assuming I haven’t already lost you, the question becomes how you can exploit the anticipated reduction in the exemption amount to take place at the end of 2025. In short, you can only exploit the anticipated reduction of the exemption amount from $14,000,000 to $7,000,000 if, prior to 2026, you have given away more than $7,000,000.
To explain using numbers:
- Let’s say you’ve gifted a total of $5,000,000 in prior years and want to completely exploit your current $14,000,000 exemption. You would make a tax-free gift of $9,000,000 and if you later died in a year in which the exemption is $7,000,000, your executor would report the total $14,000,000 of gifts. But, because of the anti-clawback treatment I referenced earlier, there would be no estate taxes payable with respect to such gifts. Of course, any other estate holdings would be estate taxed roughly 40 cents on the dollar.
- Let’s say you’ve gifted a total of $5,000,000 in prior years but don’t want to completely exploit your current $14,000,000 exemption. In that case, you could make a tax-free gift of $4,000,000 and if you later died in a year in which the exemption is $7,000,000, your executor would report the total $9,000,000 of gifts. As a result of the anti-clawback treatment, there would be no estate tax payable with respect to such $9,000,000 of gifts, but by not completely exhausting your $14,000,000 exemption you would have “squandered” $5,000,000 of the currently available exemption. And, any other estate holdings would be estate taxed roughly 40 cents on the dollar.
- Let’s say you’ve gifted a total of $5,000,000 in prior years but don’t want to take any action now. If you later died in a year in which the exemption is $7,000,000, your executor would report those $5,000,000 of gifts, and your estate holdings would be exempt from estate tax up to the $2,000,000 remaining exemption. Any estate holdings above the $2,000,000 amount would be estate taxed roughly 40 cents on the dollar.
Now, as I said earlier, the foregoing is a partial analysis and this article in no way accounts for all of the issues that should be considered in choosing whether to exploit the currently high exemption amount in anticipation of a reduction. Some of these other issues include:
- Feasability: One of the obvious concerns is whether you have holdings sufficient to withstand giving away a significant amount of assets. To be respected in the eyes of the IRS, you need to actually give away the assets and can’t retain ownership over any part of them, so unless you’re willing to part with significant wealth, you may not be in a position to try and exploit the exemption reduction.
- Time and Expense: If you make taxable gifts, you may need to involve appraisers, lawyers, CPAs, and financial advisors (among others), and their cumulative costs are substantial.
- Income tax basis: It’s important to remember that, for income tax purposes, assets received via gift have the income tax basis of the transferor whereas assets received from an estate have an income tax basis of the asset’s fair market value at the time of death. So, as part of the gifting analysis, consideration should be given to the current income tax basis of the assets and whether a basis adjustment is more beneficial than estate tax avoidance.
To conclude, there are planning opportunities available for the right clients in the right situations, but a nuanced and comprehensive approach is necessary to determine whether such opportunities are right for you. Should you have any questions or if you’d like an analysis of your specific situation, the attorneys at Noland, Hamerly, Etienne & Hoss can help.
William Henry “Bill” Falor III is an associate of the Salinas and Monterey law firm Noland, Hamerly, Etienne & Hoss. Bill focuses his practice on business and real estate transactions, estate planning and administration, and tax.
This article is intended to address topics of general interest and should not be construed as legal advice. © 2024 Noland, Hamerly, Etienne & Hoss