Prepare for the sunset of the gift and estate tax exemption
By Francis Egan and Liza Mahar
Many people think of estate planning as a “set it and forget it” kind of activity. And that excludes the large number of folks who haven’t even begun to tackle it yet, stymied by the common affliction known as procrastination.
Making the right financial and tax planning decisions for the benefit of your heirs, especially when life circumstances change, is so easy to put off until another day. This can be an expensive lesson as illustrated famously by Joe Robbie’s family, who was forced to sell the Miami Dolphins franchise due to poor estate planning, which led to an inability to pay the inheritance tax.
But, the looming sunset of the federal exemption amounts included in the 2017 Tax Cut and Jobs Act (TCJA) has created a fresh urgency for high-net-worth individuals to better understand the implications of the tax cuts that are set to expire at the end of 2025. Without additional policy changes, the tax year of 2026 could be a big shock to many U.S. taxpayers.
It is important to note the difference between the annual exclusion and the lifetime exclusion, also known as the unified credit. A donor is allowed to gift up to the annual exclusion ($17,000 per recipient in 2023) before it starts to contribute toward the lifetime exclusion. This amount has risen incrementally throughout the years and was not materially affected by TCJA.
Exclusion expected to revert back in 2026
The opportunity here is to take advantage of the massive expansion of the lifetime exclusion offered by TCJA, which is set to expire on December 31, 2025. The lifetime limits have historically increased over time, but notably, have never decreased. Without further action by Congress, this exclusion will revert back to 2017 levels (indexed for inflation).
The levels will effectively be reduced by half and are expected to be in the ballpark of $6.8 million per individual, or nearly $14 million for a married couple. By contrast, for 2023, $12.92 million per individual and $25.84 million for couples can be transferred free of tax.
For individuals with a taxable estate currently above $6 million, or married couples with taxable estates above $12 million, now is the time to review your estate plans and, where possible, take advantage of the current higher exemption amount using estate and gifting strategies.
A careful evaluation of your assets, including cash, investments, real estate and business interests, and any other asset that could potentially become part of your estate should be undertaken. In order to obtain the maximum advantage of this tax-free gifting opportunity, it is important to know what your assets are worth from a fair market value perspective, which is the standard of value required by the IRS. For instance, the fair market value of noncontrolling interests (typically those less than 50%) in closely held businesses generally includes discounts, such as the discount for lack of control (DLOC) and discount for lack of marketability (DLOM).
These discounts are routinely applied and essentially lower the value of a minority interest in a closely held business to reflect the minority owner’s inability to enact changes in the operation of a business, as well as to account for the lack of a publicly traded market for closely held firms.
Establishing a gifting plan does not always mean giving up all of the control over your assets and your legacy. Transferring assets to a trust can allow the donor to direct the funds without subjecting them to avoidable taxation. Proper planning can serve to move assets out of your estate, allowing them to appreciate without subjecting those gains to additional taxation and therefore maximizing the impact of your gift.
Cautionary case study
Consider this example: Nathan and Julia have $20 million in cash, $2 million in real estate and $8 million in a closely held business. They obtain an appraisal for the business, which concludes at a fair market value of $5.6 million for IRS purposes. That leaves them with a taxable value of $27.6 million. Through the end of 2025, they could gift up to $25.84 million tax-free. If gifted on January 1, 2026, the pre-TCJA lifetime exemption (assuming no prior gifts had been made) of roughly $13.6 million (that is $5 million per person, indexed for inflation) would be applicable, leaving $12.24 million subject to up to 40% tax.
While concerns had arisen that the sunset of TCJA would leave these previously exempt gift amounts vulnerable to future tax, referred to as “clawback,” the IRS has clarified that this will not be the case (Treasury Decision 9884, November 26, 2019).
So don’t miss out on a potential gifting strategy that keeps substantial value of a family business out of an estate, making the prospect of a much lower federal exemption in the future easier to swallow from a tax perspective.
How Wipfli can help
Right now, you have the opportunity to take advantage of generous tax exemptions by transferring part of your family wealth before the current tax provisions expire at the end of 2025. Wipfli’s business valuation professionals can help you assess the value of your family business and determine the smartest gifting strategy in your estate planning. Contact us to learn more about how we can help ensure your tax, estate, business transition and wealth management plans are aligned.
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