Part 2 of a 3-part series
Recall that the basic exclusion amount will roll back in 2026, as signed into law by then-President Trump. The exclusion in 2023 is $12.92 million, should go up a bit in 2024 and 2025, and then will be cut to about $6 million in 2026 and thereafter. If your estate is below $6 million this won’t be an issue for you. If you are single with an estate over $6 million or married with an estate over $12 million, this is a big issue for you.
IRS Regs on the Rollback
Right now, you have a large exclusion amount that can be used by gifting or by dying. Soon, the exclusion amount will be much smaller. Should you use the current large exclusion? If you do, are there any traps for the wary? The IRS answered those concerns by issuing regulations on how the large pre-rollback exclusion interacts with the reduced post-rollback exclusion.
For instance, assume you are unmarried and have an estate of $12.92 million. Here are illustrations of choices you might make and the different tax impacts of those choices:
No Gift, Death before Rollback: In 2023 pre-rollback you die, leaving your $12.92 million to your heirs. The pre-rollback exclusion amount applies. Zero tax.
No Gift, Death after Rollback: In 2026 post-rollback you die, leaving your $12.92 million to your heirs. The post-rollback $6 million exclusion amount applies. This leaves $6.92 million subject to estate tax. Pay about $2.76 million tax.
Gift before Rollback, Death before Rollback: In 2023 pre-rollback you gift $8 million to your heirs. The pre-rollback exclusion amount applies, so the gift is tax free. You retained $4.92 million. You die in 2025 pre-rollback, leaving your remaining $4.92 million to your heirs. The gift and bequest combined equal $12.92 million, and the exclusion amount is $12.92 million. Zero tax.
Gift before Rollback, Death after Rollback: In 2023 pre-rollback you gift $8 million to your heirs. The pre-rollback exclusion amount applies, so the gift is tax free. You retained $4.92 million. In 2026 post-rollback you die. The exclusion amount has been cut to $6 million. The IRS will honor the pre-rollback exclusion of the $8 million. This leaves $4.92 million subject to estate tax. Pay about $1.97 million. [Note that the IRS would honor the pre-rollback exclusion amount up to $12.92 million. The bigger the gift, the smaller the estate tax when you die.]
Gift after Rollback, Death after Rollback. In 2026 post-rollback you gift $8 million to your heirs. The post-rollback exclusion amount is only $6 million so $2 million of the gift is taxed. Pay about $800,000 gift tax. You have remaining assets of $4.12 million. You die in 2027 having already used your entire exclusion amount. Pay $1.65 million estate tax, for total tax paid of about $2.45 million.
Avoid Tax on Future Growth, too
The more you give away pre-rollback, the smaller is your after-death tax. If you do nothing before the rollback, your taxes will likely be higher when you die. The gift strategy works even better if you have an asset that is expected to grow in value significantly over the next several years. Say your $12.92 million estate contains stock worth $8 million today, but which you project may be worth $10 million in 2026, If you keep it and die in or after 2026, that $2 million of growth is subject to 40% estate tax. If you give it to your heirs in 2023 there is no gift tax on the $8 million, and when you die during or after 2026 the $2 million of growth already belongs to the children. You have avoided $800k estate tax on the $2 million growth and have avoided tax on the $8 million original value as well.
Next Week: The Planning Conundrum
Paul Premack is a Certified Elder Law Attorney for Wills and Trusts, Probate, and Elder Law issues. He is licensed to practice law in Texas and Washington. To contact us, click here.
Column published on November 21, 2022.