The holidays are usually the time to give gifts. But with new tax laws looming, the end of 2021 could see some very extravagant donations.
The tax bases of a donation
The recipient of a donation does not pay income tax on the donation. However, the donor may pay gift tax unless one of the two exemptions applies.
The first gift tax exemption is the annual exemption – anyone can give another person a gift of up to $15,000 per year. Spouses can give together $30,000 per year. After that, the gift is subject to gift tax and you will need to use the second type of exemption – the lifetime exemption.
Under current law, the estate and gift tax exemption is $11.7 million per person. You can donate up to the exemption amount during your lifetime or upon death, or a combination of both, tax-free. The exemption amount is adjusted each year and, if no changes in the law are made, it will increase to approximately $12,060,000 in 2022.
What could change?
The current estate and gift tax exemption law will end in 2025, and the exemption amount will revert to the previous law’s $5 million cap, which, when adjusted for inflation, should be around $6.2 million.
The Build Back Better bill that bounced through Congress included a provision that would accelerate the sunset provision so that the exemption drops to $6 million by January 1, 2022. As a result, estate planning attorneys have been scrambling to get blueprints. in place for clients to use the full inheritance/gift tax exemption available in 2021 in the event of disappearance.
But then, on October 29, 2021, President Biden introduced a “framework” for an amended bill that eliminated that change, leaving the current law to expire in 2025. The framework also eliminated provisions that would have destroyed many technical used by high nets. – allows taxpayers to transfer their assets to younger generations without incurring gift or inheritance tax.
Estate planning lawyers could breathe again. But not for long.
Who should act
If your net worth is less than $6 million (or $12 million for a married couple), you may not have to worry about inheritance tax. That is, unless the exemption is even lower – as Senator Bernie Sanders and others would like.
For those with estates likely to exceed $6 million per spouse, especially those whose assets are likely to appreciate significantly, now is the time to act.
What is the problem and why now?
In simplified terms, let’s assume that Harry and Neta Williams (HNW) have a combined net worth of $30 million. If they do nothing and live past 2025, they may have an $18 million taxable estate ($30 million minus $12 million in exemptions). At a tax rate of 40%, this represents a tax bill of $7.2 million.
If HNW had instead donated the maximum of $23.4 million currently under the current exemption, his taxable estate would be only $6.6 million, resulting in a tax bill of $2,520,000. $, a savings of almost $5 million in taxes. This is true even if they die in a year where the exemption is lower than it was at the time of their donations.
The inheritance/gift tax exemption is, in essence, a “use it or lose it” proposition. We have the highest inheritance tax exemption we have had since inheritance taxes existed. If it drops before you use the full amount of the exemption, it is no longer available.
Gift Transfer Techniques
You might be thinking that HNW doesn’t want to give two-thirds of his net worth to his kids just to avoid $5 million in estate tax. And that may be true. You may also think that the $2.5 million in taxes, even after their generous donations, is too much tax. This may also be true. And that’s why real estate planners are very busy.
There are techniques that can be used to leverage donations, provide an income stream to the donor, and even keep the donor in control of certain assets. Some of these techniques are
Discounted Gifts: When assets are transferred into an entity (usually a limited partnership or limited liability company), the gift of a minority stake in that entity is usually assigned a present value due to a lack of control and merchantable quality, allowing the donor to give more using less. of their exemption.
Annuity trusts retained by the settlor: It is a type of trust to which the donor transfers assets and retains a right to payment over a term. At the end of the term, the beneficiaries receive the assets and the entire capital gain. The donor also pays income tax on the income from the assets of the trust, allowing for another tax-free transfer of assets.
Sales to intentionally defective grantor trusts: The donor establishes a trust, donates some assets, and then sells other assets to that trust in exchange for a promissory note. Done well, there is a minimum donation, there is no gain on sale (for tax purposes, it is as if the donor had sold the property to himself), the donor pays the tax income and the added value is passed on to the next generation.
All of these techniques have been and likely will continue to be scrutinized by Congress, which is why it’s time to act even if the Build Back Better Act ends up failing to make estate tax changes.
The best gifting plan is often one that can be executed over time. At a minimum, we know that inheritance and gift tax exemption will drop significantly in 2026, and it’s not far off.
Teresa J. Rhyne is an attorney who practices estate planning and trust administration in Riverside and Paso Robles. She is also the New York Times #1 bestselling author for “The Dog Lived (and So Will I)” and “Poppy in The Wild.” Contact her at [email protected]