In November 2017, the IRS released proposed regulations clarifying the estate tax treatment of large lifetime gifts made now, while the federal estate and gift tax exemption is temporarily increased thanks to the Tax Cuts and Jobs Act of 2017. These proposed regulations, if they go into effect as drafted, provide an opportunity for wealthy taxpayers to lock in the temporarily increased exemption by making large lifetime gifts.
As background, after the 2017 Act, the federal estate and gift tax exemption was temporarily increased and is currently $11.4 million for individuals and $22.8 million for married couples, as adjusted for inflation. However, if Congress does not extend or make permanent the temporarily increased exemption, the exemption is scheduled to “sunset” back to pre-increase levels on January 1, 2026 and would probably then fall in the range of $6 million for individuals and $12 million for married couples.
Prior to the proposed regulations, the concern was that, with the possibility of sunset, if a taxpayer makes a large gift now, say $10 million, but dies after the exemption sunsets in 2026, that taxpayer’s estate could be subject to estate tax because the taxpayer would have died having made lifetime gifts ($10 million) in excess of the exemption in effect at the time of the taxpayer’s death (after sunset, in the range of $6 million).
Essentially, this result would deny the taxpayer the benefit of the temporarily increased exemption and would mean that the only guaranteed way for a taxpayer to lock in the temporarily increased exemption would be to actually die before the sunset occurs in 2026. Even in the context of estate tax planning, where wealthy taxpayers routinely go to great lengths to reduce the estate tax hit, planning to die before 2026 to lock in the temporarily increased exemption would be considered an especially aggressive move.
Fortunately, the proposed regulations clarify that if a taxpayer makes a large lifetime gift now, while the exemption is temporarily increased, but dies after the sunset occurs in 2026, the increased exemption will still apply to the lifetime gift made before the sunset occurred.
Assuming that the proposed regulations go into effect as drafted, this is a real opportunity for wealthy taxpayers to take advantage of the increased exemption by making large lifetime gifts now that lock in the increased exemption before the sunset occurs. However, it is important to note that the advantage here is only realized to the extent that the lifetime gifts exceed the post-sunset exemption amount (again, in the range of $6 million), meaning that this strategy is only beneficial to the wealthiest taxpayers who can afford to make lifetime gifts in excess of $6 million.
Current State of the Estate Tax: Sen. Elizabeth Warren’s Presidential Run and Tax Reform 2.0
In light of Sen. Elizabeth Warren’s (D-Mass) New Year’s Eve announcement that she is running for President, thus kicking off not only the new year, but also apparently the formal beginning of the Presidential campaign season, we thought it timely to consider the most recent estate tax proposal of Sen. Warren, and how it compares to the current state of the estate tax.
As has been widely covered, the Tax Cuts and Jobs Act of 2017 temporarily increased the federal estate tax exemption, which, for 2019, is $11.4 million for individuals and $22.8 million for married couples. However, under the 2017 Act, if Congress does not extend or make permanent the temporarily increased exemption, the exemption is scheduled to “sunset” back to pre-increase levels on January 1, 2026 and would probably then fall in the range of $6 million for individuals and $12 million for married couples.
Last year, Republicans attempted to make permanent the temporarily increased estate tax exemption as part of Tax Reform 2.0, which came in the form of three separate bills that were passed by the House in September 2018. However, with the end of the 115th Congress and with Democrats taking control of the House in the 116th Congress, it seems unlikely that Tax Reform 2.0 will be passed in its current form. As a result, the increased estate tax exemption under the 2017 Act remains temporary and is still scheduled to sunset on January 1, 2026.
But what about Sen. Warren and the estate tax? In September 2018, Sen. Warren proposed far-reaching affordable housing legislation that seeks to spend a half trillion dollars over ten years on affordable housing programs. To help pay for it, Sen. Warren proposes lowering the estate tax exemption to $3.5 million for individuals, which not only represents a substantial decrease in the current exemption but is also approximately $2 million less than even pre-2017 Act levels. In addition, the marginal rate would increase (55% for taxable estates to $13 million, 60% for taxable estates to $93 million and 65% above $93 million (with a surtax for estates over $1 billion)).
Clearly, if Sen. Warren has her way, the estate tax will be vastly different than it is now. But at this point, it is too early to tell whether Sen. Warren’s affordable housing bill or Presidential campaign will gain momentum. Stay tuned.