Sunsetting Gift Tax Exemption Is No Reason for a Large Donation

In 2024, wealthy taxpayers will be able to transfer a maximum of $13.61 million under the Tax Cuts and Jobs Act without paying any gift or estate taxes. That will drop to $5 million per individual, indexed for inflation, if Congress takes no action before Dec. 31, 2025.

Over the next two years, we can avoid donor’s remorse and bad blood with our clients by looking at their individual circumstances to determine whether using the exemption is advisable.

As a quick refresher, individuals looking to make a gift must first use any amount available under the deceased spousal unused exemption. After exhausting DSUE, they’ll use their basic exemption, and only after using the basic exemption can they use the bonus exemption—the one that may expire at the end of 2025.

There are several factors to consider before deciding whether to advise a client to use their exemption before 2025. The most important will be wealth level—clients shouldn’t make gifts they really can’t afford. Our ultra-wealthy clients are the lucky ones: Using up the full exemptions with top-offs each year should be optimal.

For clients with wealth under $7 million (or $14 million for a couple), there’s no compelling reason to make gifts now, as absent a gold rush, future available exemption will likely be sufficient to avoid the federal estate tax. The in-between clients are the ones who will require additional analysis based on marital status, age, unrealized capital gains, liquidity, lifestyle, and planning goals.

To better illustrate these factors, consider the following examples.

Widow With DSUE

An 88-year-old widow has $6 million of DSUE and $20 million in assets, $5 million of which is her primary residence. Her investments are low basis. She says she is comfortable giving away $10 million now.

It would be impossible to use her bonus exemption before 2026. Her $10 million gift would use $6 million of DSUE and $4 million of basic exemption, so she would still have approximately $3 million of basic exemption remaining before she is able to use any bonus exemption.

Even if she were comfortable gifting $15 million, that would only use $2 million of her expiring bonus exemption amount, and assuming she kept her $5 million home, she would have no other assets remaining to live on.

Further, she would lock in capital gains on the gifted assets that would otherwise be entitled to a step-up in basis upon her death. The potential sunset of the bonus exemption doesn’t justify her large gifts.

Married Couple With $15 Million

A middle-aged married couple with $15 million in assets isn’t “rich enough” to make the necessary gifts to use up their available exemptions.

Combined, the couple has approximately $28 million of exemptions to use before 2026. They would have to gift more than $14 million to fully use up their basic exemption, then any gifting more than $14 million would use the bonus exemption. If the couple wants to retain sufficient assets to live on, such gifting isn’t feasible.

After 2025, assuming the bonus exemption expires, they still will have approximately $14 million of basic exemption. The couple could consider making gifts that don’t use exemptions to keep their total asset value within their available exemption amount, even after 2025.

For example, they could make use of grantor-retained annuity trusts to remove future appreciation from their estate, make annual exclusion gifts to further reduce the value of their estate, and pay tuition and medical expenses for their children or grandchildren to move additional funds out of their estate tax-free.

Married Couple With $25 Million

A married older couple with children and grandchildren has $25 million in assets. If the bonus exemption expires, they won’t be out of the woods because they won’t have sufficient exemption to shelter their estate from the estate tax, even if they take advantage of the gifting strategies that we recommended for the middle-aged couple that don’t use exemption.

The older couple also isn’t wealthy enough to comfortably use their entire exemption prior to 2026. They are our real edge case. To use their bonus exemptions while ensuring they have sufficient assets to live on, we could advise them to fund two spousal lifetime access trusts, or SLATs. However, with two SLATs, we would have to be careful to avoid reciprocal trusts.

To eliminate the reciprocal trust risk, Spouse One could fund a SLAT for Spouse Two and their descendants, and Spouse Two could fund a dynastic trust for their descendants. During Spouse Two’s lifetime, distributions made from the SLAT could indirectly benefit Spouse One.

However, if Spouse Two died first, Spouse One would be left out in the cold—without access to either the SLAT assets or the dynastic trust assets, without enough to live on, and thinking the answer should have been no to this plan from the start.

The safest option in this case would be for Spouse One to fund a SLAT using his available basic and bonus exemption and to rely on the marital deduction and basic exemption after 2025 for their remaining assets, likely paired with some of the gifting options that don’t use exemption described above.

However, several factors could tip the scales here. A large age disparity could make the SLAT and dynastic trust option more appealing. In addition, ownership of most of the assets by one spouse necessitating a pre-gift interspousal transfer will raise the risk of a step-transaction argument seen in Smaldino v. Commissioner.

Outlook

The bottom line is that while clients may be chomping at the bit to use their bonus exemption before they “lose” them, doing so isn’t right for everyone. It’s our job to weigh the factors and make sure they understand the implications of the options we offer them.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Beth Shapiro Kaufman is partner and national chair of the private client services group and Meghan Muncey Federman is an associate at Lowenstein Sandler in Washington, D.C.

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