The 2018 tax bill (Tax Cuts and Jobs Act signed in 2017) has increased the amount an individual can give tax-free through lifetime gifts or bequests from $5.5 million to $11.18 million through the end of 2025. To take advantage of transferring your wealth tax-free at the new amount, assets must transfer before the bill sunsets at the end of 2025. However, by using your current gift exemption, you may be able to lock in your lifetime gift exemption even after the estate and gift exemptions revert to $5.5 million-dollars in 2026.
Old National trust officer, and elder law enthusiast David Sprague JD, spoke with Mike Pitts, Old National’s Director of Tax Strategy, to see how you might benefit from the short-term certainty the law now provides.
David: Mike, first of all, what is a gift tax ‘exclusion’… many people call them ‘exemptions’?
Mike: The federal government has the authority to impose a gift tax whenever an individual gives something of value to another person. There are some gifts (money, investments and other things of value) that may be transferred from one person to another without paying the Gift Tax.
These untaxed transfers are called ‘exclusions’ or ‘exemptions,’ and they fall into two categories:
- Annual Gift Exclusion: One person can gift up to $15,000 each year to as many individuals as he or she would like without incurring a taxable gift.
- Lifetime Gift Tax Exemption: Any gift above the $15,000 annual gift exclusion amount will be counted toward the Donor’s lifetime gift tax exemption (current new exemption is $11.18 million) and requires a gift tax return (IRS form 709) be filed with the IRS.
David: Why should I consider a lifetime gift if my estate is below the $11.18 million federal estate tax exemption?
Mike: The $11.18 million federal estate tax exemption is only temporary, and the amount is scheduled to revert to $5.5 million in 2026. By making a lifetime gift now, you have an opportunity to transfer wealth to another generation, which will expose less of your estate to a 40% federal estate tax on amounts above $5.5 million after 2026. By making a lifetime gift to other generations, the gift will grow outside of your estate and you will have the opportunity to see how your family uses the funds.
David: Won’t the federal government just tax my lifetime gift after the Tax Cuts and Jobs Act sunsets in 2025?
Mike: No. That’s the real news here. Recently the IRS proposed new regulations providing some certainty for lifetime gift planning.
David: What did the IRS address in these new proposed gift tax regulations?
Mike: Well, as we’ve discussed… last year’s tax cuts increased the amount individuals could give tax-free via gifts or bequests from roughly $5.5M to $11M through the end of 2025. However, there had been some concern regarding how the law change would be applied. The IRS just released proposed regulations that give taxpayers some clarity.
The regulations address the following concerns:
- The increased exemption is not applicable to prior gifts, so the amount you may pass on by gift or bequest would not be reduced by gifts given and taxed prior to 2018.
- The gift tax liability on prior gifts is removed from the computation of current year gift tax, so prior gifts do not impact the tax on current gifts regardless of whether they were sheltered by the exemption amount or gift tax was paid.
David: If a person makes gifts up to $11.18 million now, then passes away after the estate tax exclusion drops back to $5.5 million, will the estate have to pay tax on those additional gifts made while the exemption was $11.18 million?
Mike: In this situation, the existing regulations did not protect taxpayers from this result. To remedy this, the IRS drafted proposed regulations that ensure that the estate tax exemption is the greater of the current exemption amount or the exemption that was allowed when gifts were made.
David: How can our clients take advantage of this opportunity?
Mike: Certainly, they should consider gifts to children and grandchildren before the exclusion amount drops back down in 2026. A lifetime gift can be made in cash or property, but the most important question is how the gift is delivered and received by the recipient.
David: Why should I be concerned about how I make my lifetime gift?
Mike: There are many reasons why lifetime gifting is not used as an estate planning tool. Often donors are worried about the recipient’s age, spouse and any potential divorce, ability to manage a largesse, spending habits or a spendthrift lifestyle, and creditor issues, all of which could defeat the donor’s intent.
To prevent these issues, gifts to trusts are the most powerful way to leverage the lifetime gifts. By gifting to trust, the client sets the rules about how the money is invested, spent on the beneficiary and is used.
The same applies to gifts to grandchildren or great grandchildren since the generation-skipping transfer (GST) tax exemption also increased to $11.18 million under the Act. By making gifts to trusts that are exempt from GST, the client can pass wealth down from generation to generation free of transfer taxes. Additionally, the tax and estate planning opportunities in the Act make dynasty trusts something to consider when planning for future generations.
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