The Tax Cuts and Jobs Act (TCJA) introduced significant changes, notably the increase in lifetime gift, estate, and generation-skipping tax (GST) exemptions.
The exemptions rose from $5 million (adjusted for inflation) to $10 million (adjusted for inflation), equating to $13.61 million in 2024 and $13.99 million in 2025. However, absent legislative action, these exemptions will "sunset" on January 1, 2026, reverting to $5 million, potentially adjusted to approximately $7 million for inflation. This reduction means individuals could lose nearly $7 million in their lifetime gift exemption and married couples nearly $14 million. Below are planning strategies advisors can recommend to clients before the 2026 sunset.
Year-End Planning for 2024
As the year-end approaches, consider implementing the following estate planning actions:
Annual Exclusion Gifts: Make gifts of $18,000 per individual ($36,000 for married couples).
IRA Contributions: Ensure year-end contributions are made to individual retirement accounts.
529 Plans: Open and fund 529 plans for children and grandchildren, potentially front-loading with five years’ worth of exclusion gifts.
Direct Payments: Cover tuition or unreimbursed medical expenses by paying providers directly.
Charitable Giving: Finalize charitable gifts, including IRA rollovers, to secure deductions on 2024 tax returns.
Review Formula Clauses in Estate Plans
Estate plans often include formula clauses that allocate assets between a credit shelter trust and a marital trust. With higher exemptions, formula clauses may inadvertently fund the credit shelter trust at the expense of the marital trust, potentially disinheriting the surviving spouse. Advisors should review these clauses to ensure alignment with the client's intentions, particularly in states with differing federal and state exemption thresholds. Flexible drafting, such as including disclaimers, can address future uncertainties.
Basis Management in Gifting Strategies
Gifting assets during life offers transfer-tax advantages but may forgo the step-up in income tax basis upon death. High-basis assets are better suited for gifting, while low-basis assets should generally be retained to secure a basis step-up. Additionally, for trusts, strategies like granting general powers of appointment or "tripping the Delaware tax trap" can pull low-basis assets into a beneficiary's estate, optimizing step-up benefits.
Expanded 529 Plan Benefits
The TCJA expanded 529 plan uses to include up to $10,000 annually for K-12 tuition, with tax-free growth federally. However, state rules vary, so confirm state tax implications with clients. Moreover, the SECURE 2.0 Act allows beneficiaries to roll over up to $35,000 from 529 accounts to Roth IRAs, enhancing flexibility for unused funds.
Utilizing Federal Exemptions Before Sunset
With the increased exemptions set to expire, clients should consider lifetime gifts to lock in these higher thresholds. Acting in 2024 avoids potential legislative or market uncertainties in 2025. Key considerations include:
Cost of Gifting vs. Estate Taxation: Lifetime gifts avoid estate tax on the gift tax itself, reducing overall tax liability.
Asset Selection: High-basis assets are preferable for gifting to reduce capital gains exposure on future sales.
Trust Structures: Trusts, such as Spousal Lifetime Access Trusts (SLATs) and dynasty trusts, offer opportunities to transfer wealth while retaining flexibility and asset protection.
Strategic Use of SLATs
SLATs allow one spouse to gift assets while retaining indirect access through distributions to the other spouse. However, advisors must avoid the "reciprocal trust doctrine," which nullifies benefits if SLATs mirror each other. Differentiating terms, such as varying beneficiaries or distribution standards, mitigates this risk.
For uneven asset ownership among spouses, a gifting sequence involving both spouses can maximize exemption use. Timing these transactions across tax years may reduce scrutiny, as illustrated by lessons from the Smaldino case.
Additional Gifting and Trust Techniques
Clients may also consider:
Grantor Retained Annuity Trusts (GRATs): Though less attractive in high-interest environments, GRATs remain valuable for tax-efficient asset transfers.
Qualified Personal Residence Trusts (QPRTs): These can transfer property out of the taxable estate while allowing continued use during the trust term.
Sales to Grantor Trusts: Selling assets to a grantor trust can shift appreciation out of the estate, leveraging higher exemptions for larger transactions.
Loan Refinancing and Forgiveness
Intra-family loans offer tax-efficient wealth transfer options. With current high interest rates, consider forgiving existing loans to utilize exemptions or refinancing at advantageous terms.
Allocation of GST Exemptions
Review GST-exempt and non-exempt trusts to optimize allocation of increased exemptions. For multigenerational planning, allocate unused GST exemptions to trusts benefiting grandchildren or more remote descendants.
Charitable Strategies
Charitable giving combines philanthropy with tax benefits. Options include:
Charitable Remainder Annuity Trusts (CRATs): Ideal in high-interest environments, CRATs provide income streams and eventual charitable contributions.
Charitable Lead Annuity Trusts (CLATs): Effective in low-interest environments, CLATs allow appreciation to pass tax-free to non-charitable beneficiaries.
IRA Charitable Rollovers: Taxpayers aged 70½ or older can direct up to $100,000 (adjusted for inflation) annually to charities without recognizing taxable income.
Flexibility in Estate Planning
Given potential legislative changes, flexibility in estate plans is crucial. Advisors should incorporate:
Alternate funding formulas to address potential exemption reductions.
Limited powers of appointment to allow post-mortem tax planning.
Trust protectors to adjust terms in response to tax law changes.
Trust Income Tax Planning
To mitigate trust income tax exposure:
Distribute income to beneficiaries in lower tax brackets.
Evaluate whether retaining income within the trust aligns with the client’s overall tax strategy, particularly in light of Medicare surtax thresholds.
Leveraging Life Insurance
Life insurance can serve as a tool for tax deferral and estate liquidity. Review existing policies to ensure alignment with current goals and consider paying off loans against policies to maximize death benefits.
Conclusion
The TCJA’s increased exemptions provide a limited-time opportunity for wealth transfer and tax planning. Advisors should act proactively with clients to implement strategies that preserve wealth, optimize tax outcomes, and address potential sunset implications.
