For 2018-2025, the TCJA basically doubles the unified federal estate and gift tax exemption-to $11.58 million for 2020, $23.16 million for married couples. Here are the implications for folks who still have to think at least a little bit about their exposure to federal gift and estate taxes.
In 2026, the unified exemption is scheduled to revert back to the 2017 figure of $5.49 million, with adjustments for inflation for the intervening years.
Gift and Estate Tax information from the IRS
Portable Exemption Deal for Married Couples
Unused unified federal estate and gift tax exemptions of married individuals are portable, which means they can be passed along to surviving spouses [IRC Sec. 2010(c)(4)].
Thanks to the portability deal, in conjunction with the unlimited marital deduction privilege, the first spouse to die can leave everything to the surviving spouse without any federal estate tax impact, assuming the surviving spouse is a U.S. citizen and is therefore eligible for the unlimited marital deduction.
If the first spouse passes away in 2020, the surviving spouse has two $11.58 million unified exemptions to work with for a total of $23.16 million. Therefore, the surviving spouse can transfer up to that amount to his or her heirs (via bequests at death or gifts while alive) without any federal estate or gift tax impact.
For 2021-2025, the exemption will be further increased by inflation adjustments.
The unlimited marital deduction privilege is only available if the surviving spouse is a U.S. citizen [IRC Sec. 2056(a) and (d)].
As explained later, the executor of the estate of the first spouse to die must make an election to pass along the unused unified exemption to the surviving spouse [IRC Sec. 2010(c)(4)].
Example 1
Jeff, a married individual, dies in 2020 with a $9 million estate. Thanks to the $11.58 million federal estate tax exemption, he can leave his entire estate to his adult children without any federal estate tax impact. The executor of Jeff’s estate can then elect to pass along his $2.58 million unused unified federal estate and gift tax exemption to his independently wealthy wife Jill. If Jill also dies in 2020, she can leave up to $14.16 million to whomever she wants without any federal estate tax impact thanks to her $11.58 million exemption plus Jeff’s unused $2.58 million exemption.
Example 2
Assume the same basic facts as in the preceding example, except this time assume Jeff simply leaves his entire $9 million estate to Jill without any federal estate tax impact and without using up any of his $11.58 million exemption. As long as Jill is a U.S. citizen, this can be done by taking advantage of the unlimited marital deduction privilege. The executor of Jeff’s estate then elects to pass along Jeff’s unused $11.58 million exemption to Jill. If Jill also dies in 2020, her estate will have a $23.16 million exemption available (her $11.58 million exemption plus Jeff’s unused $11.58 million exemption). As a result, Jill could transfer up to $23.16 million to whomever she wants via bequests after death or lifetime gifts without any federal estate or gift tax impact.
Before the portable exemption deal, it was necessary to take tax planning steps like: (1) transferring assets between the spouses while they were both still alive in order to equalize their respective estates or to make sure each spouse’s estate was worth at least the exemption amount, and (2) setting up bypass trusts (also called credit shelter trusts) to make sure the exemptions of both spouses were taken advantage of without shortchanging the surviving spouse. Such tax planning steps are no longer necessary thanks to the portable exemption.
Determining the Portable Exemption Amount. For a spouse who dies in 2020 the maximum portable exemption amount that can be passed along to the surviving spouse is limited to the lesser of: (1) $11.58 million, or (2) $11.58 million minus the amount left in the deceased spouse’s estate. For instance, if $5 million was left in the estate of a spouse who dies in 2020 (say because that amount was left to the deceased spouse’s children by an earlier marriage), the maximum unused exemption that can be passed along to the surviving spouse is $6.58 million ($11.58 million – $5 million). [See IRC Sec. 2010(c)(4).]
Also note that only the unused exemption of an individual’s most-recently deceased spouse can be passed along under the portable exemption deal. This rule prevents an individual from piling up extra exemptions from multiple deceased spouses (the dreaded Black Widow(er) scenario). [See /RC Sec. 2010(c)(4).]
Making the Portability Election. The executor of the estate of the first spouse to die must make an election to pass along the unused unified federal estate and gift tax exemption to the surviving spouse [/RC Sec. 2010(c)(4)]. The executor must make a timely filing of Form 706 (the federal estate tax return form) to make the portability election. This is true even if the estate is too small to actually owe any federal estate tax. However, in that situation, a simplified reporting method is allowed.
Extending the Filing Deadline. Form 706 is normally due by no later than nine months after the date of death. An automatic six-month extension can be obtained by filing Form 4768.
What If Unified Exemption Reverts to Pre-TCJA Amount or Even Lower?
Proposed regulations issued in 2018 would effectively provide that individuals who make gifts in 2018-2025 to take advantage of the ultra-generous unified exemptions allowed by the TCJA for those years would not be unduly penalized if the exemptions revert back to the much-lower pre-TCJA amounts after 2025. If that scenario materializes, a decedent’s federal estate tax exemption would be the greater of the TCJA exemption amount that was utilized to shelter earlier gifts or the exemption amount that is allowed in the post-TCJA year of death. This proposed rule would be effective on and after the date it is included in final regulations. [See Prop. Regs. 20.2010-1 and -3 found in REG-106706-18.]
Cause for Alarm: There is nothing currently on table that addresses what would happen if Congress slashes the unified exemption amount after 2020, perhaps even to an amount well below what it was before the TCJA (the prior-law exemption for 2017 was $5.49 million). There has been discussion among certain politicians of cutting the exemption to $3.5 million or maybe even less if a certain party gains complete control of the federal government. There has also been discussion of increasing the tax rate (it was 55% not so long ago).
Example
In 2020, when the unified federal estate and gift tax exemption is $11.58 million, Andrea (an unmarried individual) makes $9 million of taxable gifts (gifts in excess of the $15,000 per recipient annual gift tax exclusion for 2020). Andrea dies in 2026, when the unified exemption has reverted back to only $6 million. Andrea leaves a $4 million estate. To calculate the 2026 federal estate tax liability for Andrea’s estate, add back the $9 million of taxable gifts made in 2020 to Andrea’s $4 million date-of-death estate value to arrive at a gross estate of $13 million. According to the proposed regulations, the estate tax liability of Andrea’s estate would then be calculated using a $9 million unified exemption. Andrea’s estate would owe federal estate tax on $4 million ($13 million – $9 million exemption). So, the $9 million of taxable gifts made while the much-larger TCJA unified exemption was in place would not increase the 2026 federal estate tax liability of Andrea’s estate.
Hopeful Variation: If Andrea had gave away $11.58 million in 2020, her remaining estate in 2026 would be only $1.42 million. To calculate the 2026 federal estate tax liability for Andrea’s estate, the add back the $11.58 million of taxable gifts made in 2020 to Andrea’s $1.42 million date-of-death estate value to arrive at a gross estate of $13 million. According to the proposed regulations, the estate tax liability of Andrea’s estate would then be calculated using an $11.58 million unified exemption. Andrea’s estate would owe federal estate tax on $1.42 million ($13 million – $11.58 million exemption). The $11.58 million of taxable gifts made while the much-larger TCJA unified exemption was in place would not increase the 2026 federal estate tax liability of Andrea’s estate.
Really Ugly Variation: Here is where it could get really ugly. Say Andrea gave away $11.58 million in 2020. She dies in 2021 leaving an estate of $1.42 million. The unified exemption for 2021 has been slashed to only $3.5 million, and the estate tax rate has been increased to 55%. No relief is granted for gifts made while the TCJA’s much larger unified exemption was in effect. To calculate the 2021 federal estate tax liability for Andrea’s estate, add back the $11.58 million of taxable gifts made in 2020 to the $1.42 million date-of-death estate value to arrive at a gross estate of $13 million. The estate tax liability of Andrea’s estate would then be calculated using an $3.5 million exemption. The estate would owe federal estate tax on $9.5 million ($13 million – $3.5 million exemption) at a 55% rate. The tax bill would be a whopping $5.225 million ($9.5 million x 55%). But the estate only has $1.42 million left. What happens next? Would the Internal Revenue Code then in effect allow the IRS to go after Andrea’s heirs for the difference? Probably not, but you never know.
Estate and Gift Tax Planning under the TCJA
The TCJA set the unified federal gift and estate tax exemption at $11.58 million for 2020, with annual inflation adjustments for 2021-2025. Cumulative lifetime taxable gifts in excess of the exemption are taxed at a flat 40% rate. Taxable gifts are those that exceed the annual federal gift tax exclusion, which is $15,000 for 2020 (it will probably remain at that number for several years). Taxable estate that exceed the exemption amount have the excess taxed at a flat 40% rate.
The TCJA is nothing but good news for folks with larger estates, but estate plans may need updates to take advantage of the dramatically increased exemption amounts.
Single with Estate of Less Than $11.58 Million
If your estate is worth less than $11.58 million and you die in 2020, everything you own can be left to relatives and loved ones without any federal estate tax impact. However, that does not necessarily mean you do not need an estate plan. If you have minor children, you need a will to appoint someone to be their guardian if you die. Ditto if you want to leave specific assets to specific individuals. If you are concerned about leaving money to an individual who is not financially astute, you might want to set up a trust to manage what that person will inherit.
Tax-wise, your estate planning documents may now be outdated. For example, they might direct the executor of your estate to make enough charitable donations to get the value of your estate down to the much-smaller estate tax exemption amount that applied in some bygone year ($2 million for 2006-2008; $3.5 million for 2009, $5.49 million for 2017). If so, the much-bigger $11.58 million exemption that is now in place gives you the opportunity to leave a lot more to relatives and loved ones and a lot less to charity without any federal estate tax impact. If that is what you want to do, your paperwork must be updated to make it happen.
Key Point: You could also make gifts during 2020 to whittle down your estate’s value in the hopes that it would prevent an ugly federal estate tax result if you pass away after 2020.
Single with Estate of More Than $11.58 Million
If you had died in 2010, you could have left everything you own to relatives and loved ones and no federal estate tax would have been due even if you were a billionaire. But it is a different story now with the $11.58 million federal estate tax exemption. You might want to change your estate planning documents to direct the executor to give away more to IRS-approved charities in order to get your taxable estate down to the current $11.58 million estate-tax-free ceiling .
Put another way, up to $11.58 million can be left to relatives and loved ones without any federal estate tax impact if you die in 2020. If you leave more, there will be a federal estate tax bill to pay. But the taxable value of your estate is reduced by donations that the executor of your estate is directed to make to IRS-approved charities. Of course, increasing charitable donations to avoid the estate tax means leaving less to relatives and loved ones.
Other things you can do to reduce your taxable estate include the following.
Make Annual Gifts to Relatives and Loved Ones. Thanks to the annual federal gift tax exclusion ($15,000 for 2020), you can make annual gifts to a single gift recipient up to that amount and reduce the taxable value of your estate without reducing your $11.58 million unified federal gift and estate tax exemption [IRC Sec. 2503(b)].
Example
Say you have two adult children and four grandkids. You could give them each $15,000 in 2020 for a total of $90,000 (6 x $15,000). Then you could do the same thing again in 2021 and 2022. Over the three years, your taxable estate would be reduced by $270,000 (2 x $90,000) with no adverse federal gift or estate tax effects.
Pay College Tuition Expenses (Not Room and Board) or Medical Bills for Relatives and Loved Ones. You can give away unlimited amounts for these purposes without reducing your $11.58 million unified federal gift and estate tax exemption, providing you make the payments directly to the college or medical service provider [IRC Sec. 2503(e)].
Give Away Appreciating Assets to Relatives and Loved Ones While You Are Still Alive. Thanks to the generous federal gift and estate tax exemption, you can give away up to $11.58 million worth of appreciating assets (e.g., stocks and real estate) in 2020 without triggering any federal gift tax hit. This can be on top of cash gifts to relatives and loved ones that take advantage of the annual exclusion and on top of cash gifts to directly pay college tuition or medical expenses for relatives and loved ones.
Key Point: If you make gifts in excess of what can be sheltered with the annual exclusion amount, the excess reduces your $11.58 million unified federal gift and tax exemption dollar-for-dollar.
Make Some Really Big Gifts Right Now. You could also make really large gifts during 2020 to whittle down your estate’s value in the hopes that it would prevent a very ugly estate tax result if you pass away after 2020.
Example
Say you are quite wealthy. You give assets worth $11.88 million to your favorite two relatives in 2020. That uses up your entire $11.58 million unified federal gift and estate tax exemption ($11.88 million – $30,000 for two annual gift tax exclusions= $11.58 million). But using up your exemption like this is OK if you are: (1) giving away appreciating assets to keep future appreciation out of what’s left of your taxable estate or (2) trying to avoid a really ugly federal estate tax result if you die after 2020.
Set Up Irrevocable Life Insurance Trust. As you know, life insurance death benefit proceeds are tax-free. Federal-income-tax-free that is. However, the proceeds from any policy on the client’s own life are included in his or her estate for federal estate tax purposes if the client has incidents of ownership in the policy. It makes no difference if all the insurance money goes straight to the client’s Aunt Myrtle. It does not take much to have incidents of ownership. If the client has the power to change beneficiaries, borrow against the policy, cancel it, or select payment options, the client has incidents of ownership. (The preceding is not a complete list of things that count as incidents of ownership.) This unfavorable life insurance ownership rule can cause federal estate tax exposure for clients who believe they have none.
Key Point: The life insurance ownership rule is more likely to adversely affect unmarried taxpayers. Because death benefit proceeds from a policy on the life of a married person can be left to the surviving spouse without any federal estate tax impact, thanks to the unlimited marital deduction privilege assuming the surviving spouse is a U.S. citizen (IRC Sec. 2056). In contrast, unmarried taxpayers have no such privilege and thus no super-easy way to remove life insurance death benefit proceeds from their taxable estates.
The estate-tax-avoidance solution here is to set up an irrevocable life insurance trust to own the policies on the client’s life. Since the trust, rather than the client, owns the policies, the death benefit proceeds are not counted as part of the client’s estate unless the estate is named as the policy beneficiary, which would defeat the purpose. The client is still able to direct who gets the insurance money, because the client names the beneficiaries of the irrevocable life insurance trust. There may be some complications.
When the client moves existing policies into the trust, he or she must live for at least three years. Otherwise, the death benefit proceeds will be included in the client’s estate, just as if he or she still owned the policies at the time of death. Also, when existing whole life policies are transferred into the trust, their cash values are treated as gifts to the trust beneficiaries. Finally, the client may have to jump through some hoops to get the cash needed to pay the insurance premiums into the trust without adverse gift tax consequences. All these issues can be finessed.
When the client has a really large estate that will inevitably owe some federal estate tax, he or she can set up an irrevocable life insurance trust to buy coverage on the client’s life. The death benefit proceeds can then be used to cover part or all of the estate tax bill after the client dies. This is accomplished by authorizing the trustee of the life insurance trust to purchase assets from the estate or make loans to the estate. The extra liquidity is then used to cover the estate tax bill. When the irrevocable life insurance trust is later liquidated by distributing its assets to the trust beneficiaries, those beneficiaries wind up with the assets purchased from the estate or with liabilities owed to themselves. Bottom line: the federal estate tax bill gets paid with dollars that are not themselves subject to the federal estate tax.
Married Couples
For married couples, any unused unified federal gift and estate tax exemption of the first spouse to die can be left to the surviving spouse thanks to the portability election explained earlier. That election combined with the TCJA’S increased unified federal gift and estate tax exemption amounts for 2018-2025 and the unlimited marital deduction privilege will make federal gift and estate tax bills for married taxpayers a rarity-at least through 2025. The exemption for 2020 is $11.58 million. This is all good news, but estate plans may need updates to take advantage. Here in plain English is the scoop for married clients.
Married with Joint Estate of Less Than $11.58 Million
In this scenario, there will not be any federal estate tax due even if you and your spouse both die in 2020, because the unified federal estate and gift tax exemption allows either of you to leave up to $11.58 million to your children and other relatives and loved ones without any federal estate tax hit. However, that does not necessarily mean you do not need an estate plan. If you have minor children, you need a will to appoint someone to be their guardian if you die. Ditto if you want to leave specific assets to specific individuals. If you are concerned about leaving money to a spouse or other individual who is not financially astute, you might want to set up a trust to manage assets that person will inherit.
Key Point: You could also make gifts during 2020 to whittle down your estate’s value in the hopes that it would prevent an ugly federal estate tax result if you pass away after 2020.
Married with Joint Estate between $11.58 Million and $23.16 Million
Couples in this wealth category can benefit greatly from the fact that unused unified federal gift and estate tax exemptions of married individuals are portable. So, if you die before your mate, you can direct the executor of your estate to give any unused exemption to your surviving spouse. If your spouse dies before you, he or she can do the same. Just make sure your estate planning documents are updated to say so. (We explained how to take advantage of the portability election earlier.)
Key Point: You could also make gifts during 2020 to whittle down your estate’s value in the hopes that it would prevent an ugly federal estate tax result if you pass away after 2020.
Married with Joint Estate of More Than $23.16 Million
If you fall into this category, the $11.58 million unified federal gift and estate tax exemption, the unlimited marital deduction (when available), and the portable exemption deal are all very helpful to your cause. But you and your spouse will have to do some planning to postpone and/or minimize the federal estate tax. Consider the following example.
Example
Leon and Lucy are well-off with adult children. They each have a $15 million estate (total of $30 million). Assume Leon dies in 2020. He can leave his entire $15 million to Lucy federal estate-tax-free thanks to the unlimited marital deduction privilege assuming Lucy is a U.S. citizen, and he can leave Lucy his unused $11.58 million exemption as well. That way, Lucy’s estate will have a $23.16 million exemption if she also dies in 2020. She can leave up to that amount to the couple’s children without any federal estate tax impact. As for the remaining $6.84 million in Lucy’s estate ($30 million – $23.26 million), some planning moves will be necessary to avoid a significant federal estate tax bill.
Alternatively, Leon could leave $11.58 million to the children (federal-estate-tax-free thanks to his $11.58 million exemption) and $3.42 million to Lucy (federal estate-tax-free thanks to the unlimited marital deduction privilege assuming Lucy is a U.S. citizen). If Lucy dies in 2020 with an $18.42 million estate (her own $15 million plus the $3.42 million from Leon), her exemption will shelter $11.58 million from the federal estate tax, but the remaining $6.84 million will be exposed to the federal estate tax at a 40% rate. Once again, some estate planning moves will be necessary to avoid a significant federal estate tax hit.
Key Point: The same considerations apply if Lucy is the first to die.
Key Point: The unlimited marital deduction privilege is only available if the surviving spouse is a U.S. citizen [IRC Sec. 2056(a) and (d)].
Key Point: The executor of the estate of the first spouse to die must make the portability election to pass along the unused estate tax exemption to the surviving spouse [IRC Sec. 2010(c)(4)].
Some things that can be done to reduce joint estates worth over $23.16 million include the following.
- Make Annual Gifts to Relatives and Loved Ones. See the earlier discussion in the context of single individuals. The principles are the same.
- Pay College Tuition Expenses (Not Room and Board) or Medical Bills for Relatives and Loved Ones. The principles are the same.
- Give Away Appreciating Assets to Relatives and Loved Ones While You Are Still Alive. See the earlier discussion in the context of single individuals. The principles are the same.
- Set Up Irrevocable Life Insurance Trust. See the earlier discussion in the context of single individuals. The principles are the same with one additional consideration. A married client can name his or her surviving spouse as the life insurance policy beneficiary. That way, the death benefit proceeds can be received by the surviving spouse free of any federal estate tax, thanks to the unlimited marital deduction privilege, assuming the surviving spouse is a U.S. citizen . However, this maneuver can result in too much money piling up in the surviving spouse’s estate, with the resulting large federal estate tax bill when that person dies. Bottom line: the irrevocable life insurance trust is sometimes the only way to permanently avoid estate tax on life insurance proceeds. When the client has a large estate that will inevitably owe some federal estate tax, he or she can set up an irrevocable life insurance trust to buy coverage on his or her life. The death benefit proceeds can then be used to cover part or all of the estate tax bill after the client dies. This is accomplished by authorizing the trustee of the life insurance trust to purchase assets from the estate or make loans to the estate. The extra liquidity is then used to cover the estate tax bill. When the irrevocable life insurance trust is later liquidated by distributing its assets to the trust beneficiaries (usually the client’s children or grandchildren), they wind up with the assets purchased from the estate or with liabilities owed to themselves. Bottom line: the federal estate tax bill gets paid with dollars that are not themselves subject to the federal estate tax.
Make Some Really Big Gifts Right Now. You could also make really large gifts during 2020 to whittle down your estate’s value in the hopes that it would prevent a very ugly estate tax result if you pass away after 2020.
