menu close
DiMeo Schneider & Associates

In Focus: Use It or (Potentially) Lose It

Investment Manager Research October 19, 2020

By Nicholas Breit

Principal, Director of Financial Planning

Nick provides investment consulting services to nonprofit organizations, corporate executives, family trusts and other high net worth investors. He services clients by providing advice and expertise on asset allocation, portfolio …

With estate and gifting limits currently at favorable levels, high net worth individuals have ample estate planning opportunities. However, with the presidential and congressional elections only a few weeks away, the window to act may be closing should tax reform become a reality as early as 2021.

What is the current estate exemption?

For 2020, the federal estate and gift tax exemption stands at $11.58 million per person, which means a married couple collectively has $23.16 million of estate exemption. This exemption amount covers the combination of gifts made during an individual’s lifetime and at death. Estates with assets in excess of the exemption amount are subject to a 40 percent federal estate tax.

In addition to the federal estate tax, high net worth individuals may also be subject to state estate taxes, as 12 states and the District of Columbia currently impose estate taxes.

Is the current exemption amount historically significant?

Yes. The Tax Cuts and Jobs Act (TCJA), passed in late 2017, temporarily doubled the ‘basic exclusion amount’ (BEA) from a base of $5 million per person to $10 million per person. As a result, the estate exemption jumped from $5.49 million per person in 2017 to $11.18 million in 2018. For historical perspective, the estate exemption was only $3.5 million as recently as 2009.

Is the estate exemption scheduled to decrease in the future?

The estate exemption is scheduled to remain at an elevated level through 2025, at which point the exemption would revert to $5 million per person (adjusted for inflation) in 2026. However, a future administration could push to lower the exemption amount prior to 2026.

Will individuals who take advantage of today’s elevated exemption be penalized should the amount decrease in the future?

The Treasury Department and the IRS issued final regulations in November 2019 which clarified that individuals taking advantage of the increased exemption amounts from 2018 to 2025 would not be adversely impacted after 2025, should the exemption amount drop to pre-2018 levels.

Prior to the November 2019 final regulations, high net worth individuals were concerned that a ‘clawback’ (tax) might apply should lifetime gifts exceed a future estate exemption. Per the IRS1, “the final regulations provide a special rule that allows the estate to compute its estate tax credit using the higher of the BEA [basic exclusion amount] applicable to gifts made during life or the BEA applicable on the date of death.”

What is the advantage of moving assets out of one’s estate?

For individuals who are likely to one day have a taxable estate (i.e. assets in excess of the estate exclusion), the key advantage is reducing the portion of assets that would otherwise be subject to federal estate tax. The potential federal estate tax savings could be significant should the exclusion amount decrease sharply from the current limit of $11.58 million per person.

To illustrate the potential benefit, let’s consider a hypothetical example:

John Smith makes no lifetime gifts and dies in 2028 at which point the estate exclusion is hypothetically $6.5 million. At death, John’s estate is valued at $15 million. John’s final estate exceeds the exclusion by $8.5 million and is subject to an assumed 40 percent federal estate tax. Had John instead decided to gift $10 million in 2020 while the lifetime gifting exemption was much higher, he would have only had $5 million of assets exposed to federal estate tax – a significant tax difference of $1.4 million (calculated as (($8.5 million – $5.0 million) x 40 percent)).

In this simplified example, the hypothetical federal estate tax savings are a byproduct of an estate being able to use “the higher of the BEA [basic exclusion amount] applicable to gifts made during life or the BEA applicable on the date of death,” per the IRS clarification detailed above.

Who might consider gifting additional assets?

The ideal candidates are high net worth individuals who have assets in excess of the current $11.58 million lifetime gifting exemption and who have sufficient assets for the remainder of their expected lifetime. Individuals with assets in excess of $5 million (the previous BEA (basic exclusion amount)) but below $11.58 million might weigh how much might be needed for their remaining lifetime against the potential benefit of additional gifting. Individuals with assets below $5 million may be less concerned over future tax reform and the impact on the federal estate exemption.

1IRS. IR-2019-189, November 22, 2019. https://www.irs.gov/newsroom/final-regulations-confirm-making-large-gifts-now-wont-harm-estates-after-2025.

Click here to read more of our In Focus: Use It or (Potentially) Lose It

Get the latest research directly to your inbox. Subscribe to our DiMeo Schneider Insights today.

View Related Insights

Tax Reform: On Hold for Now?

During his presidential campaign, Joe Biden outlined his tax policy proposals1, which included rolling back key provisions from the Tax Cuts and Jobs Act (TCJA). An analysis by the Tax …

    Financial Planning
Evaluating Year-End Planning Opportunities Amid Tax Reform Uncertainty

Benjamin Franklin advised, “Don’t put off until tomorrow what you can do today.” This adage feels particularly applicable to high net worth individuals concerned over potential tax reform under a …

    Financial Planning