As you plan for your future, it’s important to stay informed about changes in tax laws that could impact your estate. One significant change is the upcoming sunset of the increased estate and gift tax exemption, which was introduced by the Tax Cuts and Jobs Act of 2017.
What is the Estate Tax Exemption?
The estate tax exemption is the amount of money you can transfer to your heirs without incurring federal estate or gift taxes. In 2018, this exemption was doubled from $5.49 million to $11.18 million, and it has been adjusted for inflation each year since then. As of 2024, the exemption stands at $13.61 million per individual.
The Sunset of the Increased Exemption
However, this increased exemption is set to expire at the end of 2025. If no new legislation is passed, the exemption will revert to approximately $7 million per individual starting January 1, 2026. This creates a unique opportunity for you to transfer more assets to your heirs tax-free before the exemption decreases.
The Clawback Concern
You might be concerned about the potential “clawback” of the estate tax exemption. This refers to the possibility that the IRS could try to recover some of the tax benefits obtained from using the higher exemption amount before it expires.
Anti-Clawback Regulations
Fortunately, the IRS has issued regulations to prevent this from happening. These regulations ensure that you can calculate your estate tax based on the exemption amount that was available when you made gifts during your lifetime, not when you pass away. This means that if you take advantage of the increased exemption before it sunsets, you will not be adversely affected when the exemption amount decreases.
Disparate Opportunities to Use or Lose the Doubled Exemption
These regulations offer additional advantages to very wealthy individuals who can afford to give away amounts up to the doubled exemption amount before 2026, compared to less wealthy individuals who cannot now afford to make gifts beyond the expected sunset exemption amount. Once the exemption amount is reduced after 2025, they will only be able to transfer assets up to the lower exemption amount without incurring gift or estate tax. The temporary increase in the exemption amount thus provides a window of opportunity for individuals to transfer more assets tax-free than they would be able to once the exemption amount is reduced. However, for gifts that do not exceed the expected reduced exemption amount, this window does not offer any additional tax benefit, as the gifts would fall within the lower exemption amount that will be in effect after 2025. This creates a disparity in the tax benefits received by very wealthy individuals compared to those with less assets to give away.
Planning Opportunities
For very wealthy individuals, who can afford to give away amounts up to the doubled exemption amount before 2026, this temporary increase in the exemption amount provides a window of opportunity to transfer more assets tax-free than you would be able to after 2025.
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