Wealth Transfers Can Protect Families From Sunsetting Tax Breaks

With millions of baby boomers transitioning out of businesses, the great wealth transfer is well underway. At the same time, gift and estate tax exclusions are at all-time highs. But the increased exclusions may not last—the Tax Cuts and Jobs Act of 2017 called for the sunsetting of many provisions at the end of 2025.

One provision that now benefits high-net-worth individuals is the continued increase of the gift, estate, and generation-skipping tax exemptions, currently $12.92 million per person. With these higher exclusions, individuals can gift or pass away with almost $13 million ($26 million for married couples) tax-free. Amounts over these thresholds are taxed at 40%.

Time is ticking on the ability to use the increased exclusions, so now is the time to consider ways to shift wealth. If Congress keeps the status quo, the exclusions will likely revert to around $6.8 million (adjusted for inflation) in 2026.

To put this into perspective, a person with a non-taxable estate of $12 million will instantly have a taxable estate and potentially be subject to roughly $2 million in taxes when the higher exclusions sunset. Not using the expiring exclusion will cost this person an additional $2 million in taxes.

Because of the way the estate tax is calculated (prior taxable gifts are added to the gross estate before deducting the estate tax exclusion), what’s unclear is what would happen if a person’s exclusion at death was lower than the amount applied to lifetime gifts. What if a person made $11 million worth of gifts in 2022 but dies in 2026 when the estate tax exclusion is only $6.8 million? Would the $4.2 million difference be clawed back into the person’s estate and be subject to estate tax?

To help clarify this issue, the IRS adopted a special rule, known as the “anti-clawback” rule, in final regulations published on Nov. 26, 2019. The rule ensures that a person’s estate won’t be taxed on gifts made during the increased exclusion period by allowing estates to use the exclusion calculated for gifts made between 2018 and 2025 instead of the exclusion at death.

Despite adopting the anti-clawback rule, the IRS saw the potential for abuses in circumstances where a person makes a gift that can be included in the person’s estate as opposed to true lifetime gifts. An example is a transfer of an enforceable promissory note that remains unsatisfied at death.

As a result, the IRS issued proposed regulations on April 27, 2022, to limit the anti-clawback rule. At this point, the regulations are merely proposed, and it’s unclear when they’ll become effective. In the meantime, high-net-worth individuals contemplating making gifts should consider their options carefully.

Once the decision to make a gift has been made, the next step is to decide how best to effectuate the gift, whether outright or in trust. For a number of reasons, gifting in trust can be more advantageous than gifting outright. Trusts can protect beneficiaries from imprudent spending. Trusts can protect assets from the claims of the beneficiaries’ creditors. And trusts can be structured to avoid gift, estate, and generation-skipping transfer taxes in the future.

There’s no better time than now for high-net-worth individuals to consider intergenerational wealth transfer of family assets from one generation to the next. Depending on the assets gifted and the use of trusts, the services of valuation experts to appraise certain types of property and attorneys to draft trusts and other legal documents may be required. As the sunset approaches, it’s critical to plan for the additional time this work will take.

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

Michael Lum is an attorney and tax director with Baker Tilly’s national tax operations group. He has a diverse background working with high-net-worth individuals spanning more than a decade.

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