(The Press-Enterprise) - The holidays are usually a time of gift-giving. But with new tax laws looming, the 2021 year-end may see some very extravagant giving.
The tax basics of a gift
A recipient of a gift does not pay income taxes on the gift. However, the gift-giver may pay gift taxes, unless one of two exemptions applies.
The first gift tax exemption is the annual exemption — anyone can give another person a gift of up to $15,000 annually. Spouses can together gift $30,000 per year. After that, the gift is subject to gift tax, and you’ll need to use the second type of exemption — the lifetime exemption.
Under current law, the estate and gift tax exemption is $11.7 million per person. You can gift up to the exemption amount during life or at death, or some combination thereof, tax-free. The exemption amount gets adjusted each year, and if no change in the law is made, it will increase to approximately $12,060,000 in 2022.
What could change?
The current estate and gift tax exemption law sunsets in 2025, and the exemption amount will drop back down to the prior law’s $5 million cap, which when adjusted for inflation is expected to be about $6.2 million.
The Build Back Better bill that’s been bouncing around in Congress included a provision that would accelerate the sunset provision so that the exemption would drop to the $6 million figure as of Jan. 1, 2022. Accordingly, estate planning attorneys have been scrambling to get plans in place for clients to utilize the full estate/gift tax exemption available in 2021 should it disappear.
But then, on Oct. 29, 2021, President Biden presented a “framework” for a modified bill that eliminated this change, leaving the current law to sunset in 2025. The framework also eliminated provisions that would have destroyed many techniques used by high net-worth taxpayers to transfer wealth to younger generations without incurring gift or estate tax.
Estate planning attorneys could breathe again. But not for long.
Who needs to act
If your net worth is under $6 million (or $12 million for a married couple), you may not need to worry about estate taxes. That is, unless the exemption goes even lower — as Sen. Bernie Sanders and others would like.
For those with estates likely to exceed $6 million per spouse, especially those with assets likely to appreciate greatly, the time to act is now.
What’s the problem and why now?
In simplified terms, assume Harry and Neta Williams (HNW) have a combined net worth of $30 million. If they do nothing and live past 2025, they may have a taxable estate of $18 million ($30 million less $12 million exemptions). At a tax rate of 40%, that’s a $7.2 million tax bill.
If HNW had instead gifted the maximum $23.4 million now under the current exemption, their taxable estate would be only $6.6 million resulting in a tax bill of $2,520,000 — a savings of nearly $5 million in taxes. This is true even if they die in a year when the exemption is lower than it was at the time of their gifts.
The estate/gift tax exemption is, in essence, a “use it or lose it” proposition. We have the highest estate tax exemption we’ve had since estate taxes came into existence. If it drops before you use the full exemption amount, it’s no longer available.
Gift transfer techniques
You may be thinking that HNW don’t want to give away two-thirds of their net worth to their kids just to avoid $5 million in estate tax. And that may be true. You may also be thinking that the $2.5 million in taxes even after their generous gifts is too much tax. That may also be true. And that’s why estate planners are very busy.
There are techniques that can be used to leverage giving, assure an income stream to the donor, and even keep the donor in control of certain assets. Some of those techniques are
Discounted gifting: When assets are transferred into an entity (commonly a limited partnership or limited liability company), a gift of a minority interest in that entity is generally given a discounted value for lack of control and marketability, thus allowing the donor to gift more using less of their exemption.
Grantor retained annuity trusts: This is a type of trust to which the donor transfers assets and retains a right to payment over a term. At the end of the term, the beneficiaries receive the assets and all of the appreciation. The donor also pays the income tax on the earnings of the assets in the trust, allowing another tax-free transfer of assets.
Sales to intentionally defective grantor trusts: The donor sets up a trust, makes a gift of some assets, and then sells other assets to that trust in exchange for a promissory note. Done properly, there is a minimal gift, there is no gain on the sale (for tax purposes, it’s as though the donor sold the asset to herself), the donor pays the income tax and the appreciation is moved to the next generation.
All of these techniques have been and likely will continue to be under scrutiny by Congress, which is why this is the time to act even if the Build Back Better Act winds up not making any estate tax changes.
The best gifting plan is often one that can be executed over time. At a minimum, we know the estate and gift tax exemption will drop significantly in 2026, and that’s not very far away.
By TERESA J RHYNE
TR Law Group
November 7, 2021
Teresa J. Rhyne is an attorney practicing in estate planning and trust administration in Riverside and Paso Robles. She is also the #1 New York Times bestselling author of “The Dog Lived (and So Will I)” and “Poppy in The Wild.”
