31 Dec Don’t Knock A Gift Horse In The Mouth- 6 Ways To Use Transfer Planning To Reduce Or Eliminate Estate Tax Before Law Changes
The Tax Cuts and Jobs Act is scheduled to sunset at the end of year 2025 which is scheduled to reduce the federal and estate and gift tax exclusion to one-half of the exemption level that exists at that time. As of January 1, 2024, the federal estate gift tax exclusion is $13,610,000. It is anticipated that with inflation, the limit will be somewhere between $14 million to $15 million. As a result, it is expected that the estate and gift tax exclusion will be around $7 million to $7.5 million as of January 1, 2026.
Although most Americans do not have taxable estates (which includes life insurance, retirement accounts, etc., even if passing outside of probate), it is often important for those who have larger estates to transfer assets in ways to reduce or eliminate estate taxes. There are numerous ways that this can be accomplished through transfer planning, but this article shall discuss 6 strategies as follows:
- Maximize gifts to college plan
It is not unusual to establish a 529 plan for a child or grandchild when the child or grandchild is younger so that the amount funded could grow without taxation if used for certain college expenses. As of January 1, 2024, the annual gift tax exclusion is $18,000 ($36,000 for a married couple to gift). However, under existing law, you can give up to 5 years in advance at one time. So, as an example, grandparents (a married couple) could transfer $180,000 ($36,000 x 5) in year 2024 to a 529 account per grandchild without gift taxation although they would need to file gift tax return and elect to have this used over the 5 years. The grandparents would have to survive the 5-year period to have it fully excluded.
It should also be mentioned that as of January 1, 2024, distributions from 529s will no longer be counted as income if they apply for federal student aid.
If the child or grandchild is already going to college, direct transfers by the parent or grandparent for certain college expenses (i.e., tuition) are unlimited (not subject to the annual gift tax exclusion). Gifts to charities are also not subject to limitations.
- Gift before 2026 and get the up to the Lifetime Gift Tax Exclusion then available
If you give more than the annual gift tax exclusion (presently $18,000 as of 1/01/24), then you (as the donor) have a duty to report (file a gift tax return). However, you can give up to the amount that could pass without estate taxation (presently $13,160,000). Since the estate tax exclusion is greater now than it is projected to be in 2026, you can give more now (prior to 2026) than you can beginning in 2026 and thereafter. In other words, a donor can give up to $13,610,000 in year 2024 (assuming no prior gifts other than the annual gift tax exclusion) without gift tax. So, if the amount of what can be given at death in year of death is $7,000,000 in 2026, then gifts by the donor in excess of that amount would be subject to gift tax if made in 2026. However, if the gift is made prior to 2026, then there would be no gift tax if less than the amount that could be given that year if that is equal to or less than the estate tax exclusion (presently $13,610,000). So, if a donor gave $10,000,000 in 2024 and had no assets at the time of death, there would be no gift tax since $10,000,000 is less than the amount permitted to be given in year 2024 ($13,610,000). In effect, the gift is like a credit for what you could have given at death.
Caveat: If the donor gives the donee appreciated assets, then the donee would have to pay capital gains taxes on the appreciated asset (to the extent of the appreciation) if sold.
- Maximize gifts to ABLE accounts
If one is disabled before age 46 (i.e., receives Supplemental Security Income and Medicaid), then up to the annual gift tax exclusion ($18,000 in year 2024) can be given into an ABLE account and it will not count as a resource for means-tested public benefits for the disabled donee. However, only the annual exclusion can be given in any year. So, if parents wanted to give to an ABLE account, they can give a combined maximum of $18,000 if in the year 2024. If a gift was not made to an ABLE account, then each parent could give up to $18,000 (total of $36,000) if both parents give per year, per person without the necessity of a gift tax return. However, if the donee received such outright gifts, then the donee’s means-tested public benefits could be jeopardized.
- Irrevocable Life Insurance Trusts
Sometimes irrevocable life insurance trusts are used to pay the taxes of a taxable estate, reduce the assets of the estate and distribute the balance of the trust to the beneficiaries income tax free. The insured grantor must live 3 years after the purchase of the policy for it to not be included in the insured’s estate if an existing policy if transferred into the trust. However, if the grantor transfers money to the trust which is used to pay the first premium on a new policy, then the 3-year waiting period can be avoided. Also, the beneficiaries are given temporary rights (called “Crummey Powers”) to withdraw funds so that the gift is considered a present interest which allows the grantor to take advantage of annual gift tax exclusions.
- Defective Grantor Trusts
For those who want to retain the income or be taxed on the income from assets to be transferred, an irrevocable trust can be created where it is a completed gift (i.e., $13,610,000 is maximum in 2024) so it is not part of the donor’s estate although the donor is taxed on the income. Typically, the grantor retains a right to substitute assets or make loans without security interest.
- Non-Grantor Irrevocable Trust
Sometimes donors simply want creditor protection and they do not desire the rights to the income which can be accomplished through an irrevocable trust in which no elements of control are retained. If a gift is made directly to a beneficiary, then concerns over the beneficiary’s potential creditors, death before the donor, marital issues, disability, etc. should be considered. The irrevocable life insurance trust is also a non-grantor trust. The difference is the “Crummey Power” (the right of a beneficiary to make a withdrawal during a certain time period so that the annual gift tax exclusion can be utilized by the grantor for contributions to the trust).
There are other options (i.e., split interest trusts, etc.) in estate planning that could be considered before the end of year 2025. However, tax laws are subject to politics. So, the anticipated law changes are subject to the whims of whoever is elected to Congress.
If interested in learning more about this article or other estate planning, Medicaid and public benefits planning, probate, etc., attend one of our free upcoming Estate Planning Essentials workshops by clicking here or calling 214-720-0102. We make it simple to attend and it is without obligation.