With the end of the year quickly approaching, the time for year-end tax planning is now, especially with the impending changes outlined in the Build Back Better Act (BBBA) set to be implemented at the start of 2022. One of the major changes affects high-net-worth individuals looking to make gifts to reduce a potential future estate tax liability. Currently, the maximum gift amount without incurring the 40% federal estate tax is set to be reduced by almost half from the current $11.7 million to $6 million. As a result, those with substantial assets and their advisors have been scrambling to make gifts before the end of this calendar year to take advantage of the $11.7 million cap on gifting as outlined in the Tax Cuts and Jobs Act of 2017 (TCJA).
However, recent changes to the language in the House of Representatives’ latest proposal released on October 28, 2021 indicates an entirely new direction. It eliminates the intention to reduce the amount individuals can gift over a lifetime—at least for now. While the most current BBB Act H.R. 5376 no longer contains modifications to the estate or gift tax exclusion amounts, this current $11.7 million exclusion amount is still subject to a sunsetting provision that will result in the exemption being cut in half effective January 1, 2026 without any action from Congress. It is not unheard of for Congress to reinsert previously drafted legislative proposals at the last minute so taxpayers and their advisors should remain vigilant.
Gifting to Reduce Future Estate Tax Liability
One way to reduce tax liability is through gifting using the annual exclusion for gifts which currently remains at $15,000. This exclusion covers gifts made to each individual recipient in a tax year allowing for a taxpayer to make multiple gifts amounting to $15,000 without incurring taxes or utilizing their lifetime exemption on the gifts. Any gift made to a spouse is not considered to be under the purview of the gift tax due to separate marital deduction policies. Additionally, gifting as a married couple increases your gift-giving capacity exclusion to $30,000 per recipient, but this scenario would require a gift tax return to be filed.
Original language in the BBB also targeted typical avenues of making large gifts into trusts like Irrevocable Life Insurance Trusts, Spousal Lifetime Access Trusts, and Grantor Retained Annuity Trusts (ILITs, SLATs, and GRATs). This is no longer the case if the latest BBB update becomes the final version—though this is not guaranteed. The BBB Act would have targeted these kinds of trusts even if they were established prior to the BBB and includes any future contributions to the trusts that are included in the donor’s estate at death. It would still be possible to avoid some of these tax complications if this provision is ultimately revived by, for example, fully funding an ILIT to cover future life insurance premiums in a lump sum instead of making regular annual gifts to the trust that would be subject to taxes.
Gift When Your Value is Low
As business owners are considering transitioning their business to the next generation, some have experienced a devaluation of their assets during the pandemic and as a result now may be the time to make a gift to their family. At the end of the day, the best time to gift is often when the value of assets is low, so the amount of lifetime exemption used is also low. This allows you to transfer the most assets that could experience appreciation. On the other hand, the basis of an asset that is received as a gift is a carryover basis, so that means the donor is also potentially transferring an income tax liability to the beneficiary. This conflict means taxpayers will need to carefully weigh the options, and discuss the impact of their decisions with their tax and legal advisors.
Charitable Giving to Reduce Taxes
Another means of reducing your future estate tax liability and your current income tax liability is by charitable gifting. The 2020 Coronavirus Aid, Relief, and Economic Security Act (CARES Act) contains provisions that encourage additional charitable giving and has been extended through the end of 2021. These provisions allow for $300 above-the-line deductions for charitable gifts made in cash for non-itemizing taxpayers. This also increases the charitable deduction from an adjusted gross income cap of 60% to 100% for some contributions by taxpayers who itemize, and increases the limit of the corporate tax deduction from 10% to 25%. With the increase in these deduction caps, now is the time to discuss funding a Donor Advised Fund or other vehicles to accelerate charitable giving.
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