It has long been a maxim in estate planning that it is worthwhile to make gifts. The effect of a gift is to remove from your estate the appreciation in the asset that was gifted. In addition, in many types of gifts, such as interests in partnerships or limited liability companies, it is possible to take a discount for lack of marketability or minority interest in valuing the gift. A 25% to 35% discount is somewhat standard. A gift that would otherwise have a value of $1 million would only wind up being a gift of $650,000 - $750,000. This further enhances the effect of the gift. If the value of the gift grows to $2,000,000 during the lifetime of the donor, then $1,250,000 - $1,350,000 has been removed from the donor’s estate. A life insurance trust can be used to leverage gifts of the premium many times over when the life insurance proceeds are eventually received.
Under current law, there is a unified exemption for gifts and estates, which currently is $11,580,000 per donor or deceased individual. This exemption can be used either during lifetime or upon death, or a combination thereof. Thus, if someone makes a gift of $5,000,000 in 2020, they would then have $6,580,000 left of their exemption to use upon their death. Current law provides for the estate tax exemption to increase each year through 2025. However, the Internal Revenue Code provides that in 2026 the estate tax exemption will decline to $5 million as adjusted for inflation from 2017. This number may be slightly above $6 million in 2026.
In light of the substantial budget deficits that have been created during 2020 as a result of the COVID-19 pandemic, it is likely that no matter who wins the presidential election, there will be a need for increased taxes to cover the deficit. Many commentators feel that if the Democratic Party gains control of the presidency and the Congress, the proposals that have previously been suggested by the Democrats will be made into law in order to raise additional taxes. This could result in a substantial reduction in the gift and estate tax exemptions. Past proposals from the Democrats would provide for the splitting of the estate and gift tax exemptions so that they are no longer unified. Instead, there would be a gift tax exemption of $1 million for lifetime gifts and an estate tax exemption of $3.5 million for transfers at death (less any amount of the gift tax exemption that was used.) In addition, the current tax rate of 40% for taxable estates and gifts could be increased to 55%.
Therefore, for any individual who could likely have an estate of greater than $3.5 million or married couple with an estate of over $7 million, there may be incentive to make substantial gifts during 2020 utilizing the current high exemption amounts. The Internal Revenue Service has ruled that gifts that are made in 2018-2025 using the higher exemption will be respected and will not be “clawed back.” For example, if a gift is made by a single individual for $5 million in 2020, and that individual dies when the estate tax exemption is $3.5 million, that individual’s estate will not have to pay back the extra $1.5 million. In other words, while the individual would have used up their $3.5 million exemption because of the gift in 2020, they are not liable for the tax on the extra $1.5 million that was gifted in 2020.
Of course, gifts can be made outright or in trust. A gift tax return would need to be filed to report the gift. The taxable amount of the gift is the amount that is greater than the annual exclusion for the year. The annual exclusion currently is $15,000 per donee. Thus, if an individual makes a gift of $5,015,000, he or she would report a taxable gift of $5 million, which would be offset by the current $11.58 million exemption.
An advantage of gifting during lifetime is that the donor can (hopefully) receive enjoyment watching the donee properly using and enjoying the money or other assets that were gifted. Of course, it could also be a learning experience to see how the beneficiary uses the gift. If the donor does not like how the donee used the gift, they can make changes to their estate plan, such as holding assets in trust rather than distributing them outright to a donee who squandered the money that was gifted to them.
The estate planning attorneys at Maddin Hauser are ready and able to assist our clients in developing gift plans. There are a number of different gifting vehicles that can be utilized to make substantial gifts while taking into account discounts or keeping that gift within the family. However, these gifts should be finalized and completed by December 31, 2020 to protect against a reduction in estate and gift taxes that may occur in 2021.
We look forward to speaking with you.