Estate Tax Cliff: Sunset of the TCJA Federal Estate Tax Exemption

06 Aug

Estate Tax Cliff: Sunset of the TCJA Federal Estate Tax Exemption

attorneys discussing estate tax exemption

By James A. Spella Schloemer Law Firm, S.C.

Proper planning is critical for all couples, regardless of the size of their estate, to achieve their personal objectives. With the sunset of the Exclusion Amount, it is crucial that all couples have a plan in place which meets their personal objectives without unnecessarily providing funds to the federal coffers.

Many couples have excellent planning in place, and routinely review and update. These are often those couples with significant wealth. They are aware of the importance of “tax-efficient” planning.

For those couples of modest wealth—but certainly wealth significant to them, their families, and unfortunately the IRS—it is critical that they put in place planning to achieve their personal objectives in a tax-efficient manner. Their planning need not be as complex as other couples but should perhaps still contain planning documents and utilize techniques to protect their wealth for each other and then their families.

Planning in 2024 and 2025 should be based on the presumption that the Exclusion Amount will sunset.

BACKGROUND

Exclusion Amount

A bit of history. On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA) which went into effect on January 1, 2018. As part of this legislation, the estate tax exemption was increased from $5.49 Million in 2017 to $11.8 Million in 2018 and is annually adjusted for inflation. In 2024 the exemption amount is $13.61 Million, meaning that if someone were to pass away, he or she could leave up to $13.61 Million of their estate to someone without any of that $13.61 Million being subject to estate tax.

The 2017 exemption is the Basic Exclusion Amount (BEA), which was then increased by the TCJA Exclusion Increase.

The TCJA sunsets on January 1, 2026, and thus the BEA will decrease to an amount equal to the 2017 exemption adjusted for inflation, estimated to be approximately $7 Million.

DSUE — Deceased Spouse’s Unused Exclusion

The exclusion amount is calculated on an individual basis. This personal exclusion amount can be increased by any portion of a deceased spouse’s exclusion amount that he or she did not use during his or her lifetime. Since all transfers on death from a deceased spouse to a surviving spouse are not subject to estate tax (tax-free marital deduction transfers), the deceased spouse will not utilize his or her exclusion amount. Therefore, the amount not used in the deceased spouse’s estate can be “portable” and added to the exclusion amount of the surviving spouse by filing a Federal Estate Tax Return claiming such portability.

Here are two examples to illustrate.

Example 1: A couple with a combined estate of $6 Million — $3 Million each. Spouse dies and leaves his or her entire estate to surviving spouse tax-free as tax-free marital deduction transfer. This means decedent spouse dying in 2024 will not have used his or her $13.61 Million exclusion comprised of the BEA plus the TCJA increase. If decedent’s estate makes the protective DSUE election, the unused exclusion amount will be added to that of the surviving spouse.

In this example, the surviving spouse may choose not to file the protective election since the surviving spouse’s individual exclusion amount is adequate to protect their estate from federal estate taxes, even after sunset. ($6 Million estate, $7 Million post sunset exclusion).

What is important to remember: Use it or lose it. If you don’t make the election for DSUE, it is lost.

Example 2: $26 Million estate, $13 Million each, both spouses die in 2024. Husband leaves his half to wife tax-free as marital deduction. DSUE election made transferring deceased husband’s $13.61 Million exclusion to wife. Wife dies later in 2024 with an estate of $26 Million. The wife’s estate transfers tax-free to heirs utilizing the wife’s exclusion amount of $13.61 Million and the $13.61 Million DSUE from husband covering up to $27.22 Million — $1.22 Million more than they left to their heirs. If the DSUE election had not been made, there would have been federal estate tax due on the wife’s estate greater than $13.61 Million at the rate of 40%; in this case, a tax on $12.39 Million leading to nearly a $5 Million estate tax.

Note: These examples are not meant to provide all the planning options available but are meant to demonstrate the importance of using the deceased spouse’s exclusion amount.

ORDERING OF EXCLUSION AMOUNT

An individual’s exclusion amount may be composed of three (3) amounts:

First: DSUE (transferred from decedent spouse to surviving spouse)

Second: BEA (the basic exclusion without the TCJA increase)

Third: TCJA Exclusion Increase

It is in this order that the exclusion amount is applied to lifetime gifts and transfers at death. This means that the First and Second amounts must be utilized first before having the benefit of the TCJA Exclusion Increase.

NEXT STEPS—PLANNING FOR COUPLES BY VALUE OF WEALTH

Combined Estate Value of $12 Million or less

Even with the sunset of the TCJA Exclusion Increase, these estates are adequately protected from federal estate tax with each spouse’s BEA estimated to be $7 Million in 2026, or $14 Million for the couple. With proper wills/living trusts and DSUE election utilizing this combined exclusion, no additional special planning techniques are needed.

At a minimum, these couples should have planning documents that ensure the use of both spouse’s BEAs to eliminate federal estate tax. This generally is accomplished by the DSUE or distributions from the decedent spouse to the surviving spouse in trust using up the decedent spouse’s BEA.

Caveat: These couples need to consider whether their estate size will increase by appreciation, inheritances, etc. If this is likely, then this couple’s planning should be similar to those with combined estates of $12 Million or more.

Combined Estate Value of $12 Million or more up to $30 Million

(This could also include couples with less who anticipate growth)

These couples need to address the sunset of the TCJA Exclusion Amount. If not used by either spouse prior to 2026, the TCJA Exclusion Amount will be lost – use it or lose it.

A couple could “bet” on the future and hope that the TCJA will be extended and do nothing.

Or the couple could utilize at least one spouse’s TCJA Exclusion Amount in 2024 or 2025. The thought process should start now with the plan to “pull the trigger” on planning in 2025 when the tax and political environment suggests the likelihood of the sunset.

Remember, to use the TCJA Exclusion Amount, a spouse must utilize the BEA (and DSUE if applicable) before the TCJA Exclusion Amount is available for use.

Example for illustration purposes only:

Couple has estate of $30 Million. Wife creates a trust for the benefit of the husband (Inter-Vivos QTIP Trust, see below) which provides for mandatory income and discretionary payments to husband for life, and at husband’s death distributed to children. Wife gifts $13.61 Million to the trust which represents her:

Second Tier BEA of $6.805 Million

Third Tier – TCJA Exclusion Amount of $6.805 Million.

(BEA is as of 2024 – if created in 2025, these amounts will increase to match inflation).

Note that Second Tier transfers must exhaust the BEA amount before the Third Tier TCJA Exclusion Amount is available for use.

The example intentionally utilizes an Inter-Vivos QTIP Trust.

Inter-Vivos: created during lifetime.

QTIP: Qualified Terminable Interest Property. A QTIP election on the gift tax return by the donor spouse allows the donor spouse to treat the trust as a gift to the spouse and eligible for the tax-free marital deduction transfer so as to not utilize the BEA and TCJA Exclusion Amount.

This Inter-Vivos QTIP Trust allows the taxpayers to “toggle” the tax implications until the due date of the Gift Tax Return (Form 709), which is normally April 15, but with extension is not due until October 15 of the year following the year of the gift.

So, a 2025 Inter-Vivos QTIP Trust would have until October 15, 2026, to make the QTIP election. If the election is made, the trust would be a tax-free marital deduction gift and will be part of the donee’s (husband’s) estate. This election would be made if there was an extension of the TCJA Exclusion Amount – that way, the wife doesn’t have to use up her TCJA Exclusion Amount if she doesn’t want to.

If the QTIP election is not made, the 2025 trust would be considered a completed gift and would use the wife’s BEA and TCJA Exclusion Amount and would not be part of the donee’s estate. The election to treat it as a completed gift would be made if there is a sunset so the wife could take advantage of using the TCJA Exclusion Amount while she still can– here, you use it, so it’s not lost.

This example is a “Wait and See” option. Do the planning, and then toggle depending on whether the Exclusion Amount Increase is extended or sunsets.

Example Variation: One spouse utilizes the BEA and TCJA Exclusion Amount in completed gifts to others, i.e. children, grandchildren, outright or in trust. The couple believes its retained estate is sufficient for their financial security. This also will “use it” and not “lose it” as to the TCJA Exclusion Amount.

Combined Estate Value of more than $30 Million or more

This $30 Million value is utilized to address the planning of couples with significant wealth. This is not the exact value of an estate that needs more complex planning, but merely is a benchmark that if a couple is near, should prompt them to consider the level of planning they will need to minimize federal estate tax exposure.

This couple should consider planning techniques to utilize the TCJA Exclusion Amount before it sunsets. These techniques include, by way illustration but not limitation, discount gifting, irrevocable completed gifts, charitable gifting, and gifting to each other in a manner which provides financial security, removes assets from their respective estates, and utilizes the TCJA Exclusion Amount. “Use it or lose it.”

Note:

This blog does not detail these planning techniques. They are complex and must also address the personal objectives and financial security of the couple.

It is our experience that these couples are aware of their federal estate tax exposure and routinely review and update their planning documents. These couples can consider completed gifts for which they do not retain any benefit because their retained wealth is sufficient to provide financial security.

Additionally, it is our experience that couples with less significant wealth do not have a tax-efficient plan in place, or if they do, it is not routinely reviewed and updated, which is especially problematic given situations like the sunset of the Exclusion Amount.

SUMMARY

Regardless of the size of a couple’s estate, from the planning perspective of being tax-efficient, the sunset of the TCJA Exclusion Amount should not be overlooked.

It may mean do nothing, create a “wait and see” plan, or utilize the TCJA Exclusion Amount.

Questions?

If you have questions about this article or need assistance, please contact this article’s author or one of our business law attorneys at Schloemer Law Firm, S.C at [email protected] or 262-334-3471.

We frequently represent individuals in their legal matters, focusing primarily on providing business, real estate, and estate planning legal services in Washington, Ozaukee, Dodge, and Fond du Lac County and the communities of West Bend, Jackson, Slinger, Hartford, Kewaskum, and other surrounding communities.

Originally published: August 6, 2024.