One of the provisions of the Tax Cuts and Jobs Act of 2017 (TCJA) was to increase the federal estate and gift tax exemption to $10 million per individual/$20 million per married couple. The $10 million/individual and $20 million/married couple estate and gift tax exemptions are indexed to inflation.
The estate and gift tax exemptions are combined and represent the maximum amounts that an individual or married couple can gift during their life or bequest at their death without incurring any federal estate or gift tax.
For 2023, the federal estate and gift tax exemption is $12.94 million per individual and $25.94 per married couple. For 2024, the exemption amount is estimated to increase (indexed to inflation) to $13.61 million per individual and $27.22 million per married couple. For 2025, the exemption amount could rise to $14 million/$28 million.
What happens to the increased estate and gift tax exemption after December 31, 2025? The estate and gift tax exemption increases resulting from the TCJA will expire on December 31, 2025 unless Congress renews the exemption increases. Effective January 1, 2026., unless Congress takes action, the gift and estate tax exemption will be reduced to $7 million per individual and $14 million per married couple.
Before discussing the action affected federal employees and retirees are advised to take in anticipation of the possible 50 percent reduction in the estate and gift tax exemption on January 1, 2026, it is important to discuss what the federal estate tax is, and how a gifting program can minimize the possibility that an individual’s estate could be subject to the federal estate tax when the individual dies.
The federal estate tax, sometimes called the “death tax,” is a tax levied on the value of an individual’s estate at the time of his or her death. In 2023, federal estate tax rates range from 18 percent to 40 percent and will be imposed on estates valued over $12.92 million.
Many individuals with sizeable estates plan upon their death to bequest cash, securities, real estate and property they own to their family members. However, those individuals who have sizeable estates are advised to use a combination of lifetime gifting and bequests at death to ensure that the estate will be small enough so as not to be subject to federal estate taxes. In so doing, the individual who spent a lifetime saving and accumulating assets will minimize the possibility that their estate will be subject to federal estate tax.
Besides the federal government, there are 12 states and the District of Columbia that have a state estate tax. Two of these states – Massachusetts and Oregon – currently have a state estate exemption amount of $1 million. Washington state has an exemption of $2.193 million, while Minnesota has an estate tax exemption of $3 million.
While it is fair to say that most federal employees and retirees unlikely to be affected by federal estate taxes should they die between now and 2026, more employees and retirees could be affected by the federal estate taxes starting in 2026 when the federal estate tax exemption could be lowered to $7 million.
Those employees and retirees living in states with low state estate tax exemptions are more likely to be affected by state estate taxes. When an individual considers what is included in his or her gross estate – real estate (principal residence, vacation home, rental property), checking and savings accounts, investment portfolios including stocks, retirement accounts such as the TSP and traditional and Roth IRAs, and life insurance policies, a $2 to $3 million gross estate is not uncommon among many individuals including federal employees and retirees.
How to Make Gifts to Reduce an Estate
The simplest way that an individual can reduce his or her estate during lifetime is through a program of direct gifting of cash, securities (stocks, bonds, ETF’s, mutual funds) and other property. During 2023, the limit on annual gift tax-free gifts is $17,000 per individual. What that means is that during 2023, any individual can make tax-free gifts of up to $17,000 to an unlimited number of other individuals. A married couple can jointly gift $34,000 to an unlimited number of other individuals during 2023.
The $17,000/$34,000 tax-free gifting amounts during 2023 mean that provided any gifts (cash, securities, etc.) valued below those amounts will not result in the gift donors being subject to the federal gift tax. Those gift donors who make gifts over $17,000/$34,000 during 2023 will have to report those gifts on IRS Form 709 (United States Gift Tax Return).
IRS Form 709 must be filed no later than April 18, 2024. By reporting these gifts on IRS Form 709, the individual will use the gift tax exemption in effect the year of the gifts ($12.92 million during 2023) and therefore will not be subject to the federal gift tax. Also, any gifts below $17,000 do not count against the larger $12.92 million combined gift- and estate-tax exemption during 2023. The $17,000/$34,000 tax-free gift limit during 2023 is likely to rise to $18,000/$36,000 during 2024.
The one exception for lifetime gifting is for securities such as long time-held stocks that have appreciated in value. In that case, the issue is particularly complicated. Gift recipients (the gift “donees”) who receive securities (for example, stocks, bonds, ETFs, mutual funds, etc.) get the original cost basis of the gift donor.
This means that when the gift donee sells the security, the gift donee will owe federal capital gain taxes. The amount of capital gains tax could be substantial especially if the security has appreciated over a prolonged period of time.
The alternative is for the gift donor to hold the appreciated securities until his or her death rather than gifting the security during his or her lifetime. In so doing, the security would get a “stepped-up” in cost basis to the value of the appreciated security at the time of death. In that case, if the security were to be sold shortly after the security is inherited, the amount of federal capital gain tax due would be minimal.
When to Use a Trust
Those individuals with family members (especially children) facing the possibility of being subject to federal and/or state estate taxes may want to consider making gifts to a dynasty trust. In so doing, the individual can preserve more wealth for the individual’s children.
A dynasty trust removes the assets from both an individual’s estate and individual’s children’s estate. Those trusts typically benefit children and most likely grandchildren and future generations.
Trust can also offer asset protection. By gifting assets directly to children, the children could lose some of the assets if they get sued or divorced. By contrast, when a donor gifts to a trust, it is harder for a creditor to go after the trust principal.
How Much Should an Individual Gift to Other Individuals?
It is important for individuals who are contemplating a gift-giving program to keep enough of their assets in their estate in order to maintain their lifestyle. This is particularly important during a time of high inflation and volatile stock and bond markets, which is currently happening and may persist for many years.
Federal employees and retirees who have questions and need additional information on what they need to do to avoid potential federal and state estate taxes are advised to talk to an estate attorney practicing law in the state or the District of Columbia in which the employee or retiree is a legal residence.
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER®, Chartered Life Underwriter, Chartered Financial Consultant, Registered Health Underwriter and Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019