As of sunrise on January 1, 2024, certain tax thresholds change. As of sunset on December 31, 2025, there is an important tax exemption reduction of which you should be aware.
The cost-of-living adjustments (“COLA”) to the Federal gift and estate tax thresholds have been announced for 2024. The annual gift tax exclusion amount will increase from $17,000 to $18,000 per donor, per donee. Although seemingly modest, it has been said that the single most powerful tool in moving wealth tax efficiently is the regular, annual use of this exclusion. Of course, it should be judiciously applied, ideally through a trust rather than directly to the individual donee. Over ten years at this rate, a married couple with three children could transfer $1,080,000 with no transfer tax effects. That is a savings of over $400,000 in estate tax, using the current (40%) tax rate.
In addition, the Federal gift and estate tax exemption will increase from $12,920,000 to $13,610,000 per taxpayer for 2024. This amount will increase by COLA again in 2025, and then again in 2026, but more importantly in 2026 this exemption will be reduced in half. These current amounts are due to a doubling of the prior exemption threshold by the Tax Reform Act of 2017, and the doubling “sunsets” as of 2026. It is anticipated this may result in an exemption in 2026 of some 7 plus million dollars, assuming Congress does not change the law.
As with all sun setting laws, this window of time until the sunset date (here, 1/1/26) presents an opportunity of whether to use the higher exemption, before losing it. The first step in the analysis is determining the amount of resources you anticipate needing for the rest of your life. If your asset base is more than needed for your anticipated expenses, the excess amount is “legacy money.” Two concepts are relevant in determining when to make gifts of legacy money. One is the time value of money; that simply means the earlier you make the gift, the better. Said another way, if you give $100,000 in 2023 and it doubles in ten years, you have avoided transfer taxation on the $100,000 growth without using exemption on it. Whereas, if you wait to make the gift at the ten year mark, you must use $200,000 of your exemption, rather than just the original $100,000 amount.
The second relevant concept relates more directly to the sun setting law. At this time, a taxpayer can transfer over $13M free of gift/estate tax, but can only transfer approximately $7M in 2026. Think of it as a “use it, or lose it” proposition as to the $6M+ difference. In effect, the $6M is “bonus” exemption for those who make gifts before 2026. To illustrate, let’s assume you have legacy money of $10M. Then you should consider making a gift of that $10M, and you could view the $10M gift as using $3M of the bonus exemption. In other words, if you waited to transfer this until 2026 (by gift or death), the $3M bonus exemption would have disappeared, and the result would be a transfer of only $7M tax-free. The gift/estate tax on the additional $3M of the gift would be $1.2M (using the current 40% tax rate). In addition, when you make the gift, you take advantage of the time value of money concept, meaning the future growth on the $10M is excluded from your taxable estate as well.
Farner & Perrin stands ready to assist you in wealth transfer planning to utilize your bonus exemption, and to optimize the design of trusts to receive these gifts. Be aware that some of the sophisticated wealth transfer strategies require substantial time to implement, and we advise against waiting until 2025 to initiate this project. Swiftly fly the years.