Estate Tax Exemption for 2024 and beyond

What is the Estate Tax Exemption?

In 1789, Ben Franklin penned the famous phrase “In this world, nothing is certain except death and taxes”. It was not until 1916 that the estate tax was instituted, and death itself became taxable.

There are certain amounts that are exempt from the federal estate tax. Under the 2017 Tax Cuts and Jobs Act, the estate tax exemption of $5.18 million per person was more than doubled to $11.18 million and adjusted for inflation annually. As of 2024, the inflation adjusted amount is $13.61 million per person.  For a married couple, with proper planning, the total exemption is $27.22 million.  Anything above those amounts is taxed.

What is the Estate Tax Sunset Provision?

The Tax Cuts and Jobs Act also established a “sunset provision,” meaning that beginning in 2026, the exemption amount would revert to its 2017 level; inflation adjusted. I estimate that the 2026 exemption amount would be just under $7 million; or $14 million per couple.

That said, tax policy is like a political football, and it bounces like an onside kick. An election year makes it even more unpredictable. Congress could do any of three things:

  1. Do nothing, allowing the sunset provision to go into effect
  2. Cancel the sunset provision, which would leave the current exemptions in place
  3. Change the entire estate tax scheme

If congress fails to act, the sunset provision will come into effect. The exemption would be reduced, and the estate tax top rate would increase from its current 40% to 45%. Applying the rules, a single person with a $10 million estate after sunset would pay tax of over $1 million. It is worthwhile to attempt to mitigate taxes of this magnitude.

The tax risk is higher for those with expected longevity. For example, if we assume that same $10 million estate grows at a rate of 6% for twenty years, it has a terminal value of approximately $32 million. The estate rules in twenty years are unknown, but there is a risk that a more punitive scheme could come into effect within that time, resulting in that estate being assessed a very large tax of $10 million or more.  I advise taxpayers to consider not only the present value of their estates, but also the projected future value at life expectancy.

One potentially helpful tool for mitigating estate taxes is to make a tax-exempt gift before the sunset provision takes effect. Exempt gifts made now remove not only the current value of the gift from the taxable estate, but also the future growth of those assets. Current gifts also reduce the risk of more punitive estate tax rules in the future.

Is There a Clawback Provision on Gifts After the Estate Tax Exemption Sunsets?

A factor to consider is the question regarding a “clawback” of the exemption after sunset.

In the clawback scenario, an exempt gift made before sunset would be taxed to the extent it exceeds the lower exemption amount after sunset. For example, if a taxpayer made an exempt gift of $12 million before sunset, and the exemption amount is subsequently lowered to $7 million, the $5 million excess would be taxable.

Fortunately, in 2019 the IRS issued final regulations creating a rule to address this issue, known as the “Anti-Clawback” Rule. The rule states that estates will not be taxed on completed tax-free gifts made before sunset. After sunset, the exemption will be the greater of previous gifts or the current exemption amount. In our example above, the taxpayer’s exemption after sunset would still be $12 million.

This illustrates the power of giving before sunset. Our taxpayer in the example above retains the $12 million exemption, whereas those who made no gifts before sunset are restricted to the new $7 million exemption amount.

Note that if a taxpayer does not have the ability or the intention to give more than the reduced exemption amount, there is no advantage to giving before sunset. For example, a taxpayer who gives $7 million before sunset could have waited until after sunset and given the same amount under the reduced exemption.

Bear in mind that gifting certain assets is not advisable or even allowed in some cases:

  • Retirement plans such as IRAs and Roth IRA cannot be given during life without first liquidating the account, which results in adverse income tax results.
  • Personal residences are not normally given during life, both for personal and income tax reasons.

The remaining assets are often not of sufficient value to exceed the reduced exemption amount that would come into play after sunset.

It is also worth noting that techniques used to reduce the estate tax will often increase the income tax to the heirs. Charitable gifts are an exception.

Conclusion  

In summary, taking advantage of the current high federal estate exemption before sunset may prove to be a workable strategy for investors with more than $7 million in assets, ($14 million for a married couple) after excluding the personal residence, IRAs, 401(k)s and other qualified retirement plans.

There are numerous considerations to be weighed before giving away assets. A few examples:

  • Before giving, it should be established that there are more than sufficient remaining assets to accomplish all the lifetime goals.
  • It may be desirable to retain significant excess assets to mitigate potential long-term care expenses.
  • Rather than outright gifts, an irrevocable trust may be considered. Gifts to an irrevocable trust can reduce the taxable estate, while achieving other goals. For example, a trust can provide lifetime income for the grantor, or it can protect assets for beneficiaries who are inclined to spend frivolously.
  • If there are charitable beneficiaries in the will, those testamentary gifts will reduce the estate. Lifetime gifting may not be necessary at all to stay under the exemption amount.

After the November 2024 elections, we hope to have more clarity about tax policy, giving us a full year to act before the sunset provision is scheduled to go into effect. For now, I encourage taxpayers and their advisors to become fully informed about current tax rules as they apply to the sunset provision. The planning and drafting of an estate plan takes time, and we want plans in place before 2026.

Remember that general advice such as this is not intended for any specific situation. For advice regarding strategies that may benefit you, rely upon the advice of a competent CFP®, Estate Attorney, and CPA.  Ideally, all three professionals coordinate advice and work as a team for your benefit.

James Twining
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