2023 Tax Inflation Adjustments Announced By The IRS Provide Estate And Gift Planning Opportunities
The IRS recently announced inflation adjustments for tax year 2023. These adjustments include various different items, including adjustments to the standard deduction, income tax brackets, alternative minimum tax exemption amounts, the earned income tax credit, etc.
The announcement also includes changes to the estate, gift and generation-skipping transfer (GST) tax exemptions. These higher exemption amounts provide planning opportunities for 2023. To fully understand these opportunities, some background is in order.
The Tax Cuts and Jobs Act (TCJA), which was passed in December 2017 and generally effective January 1, 2018, doubled (on a temporary basis) the estate, gift and GST exemption amounts. Absent future action by Congress, various of the changes brought about by the TCJA, including the increased exemption amounts, will sunset after December 31, 2025. At that time, the exemption amounts will automatically revert (again, absent action before then by Congress) to the base exemption amounts that existed prior to the passage of the TCJA, adjusted for inflation. Currently, the federal estate tax exemption amount available as of January 1, 2026 is projected to be approximately $7,000,000 per person, compared to that available in 2022, which as explained below, is just over $12,000,000 per person.
For 2022, the federal estate, gift and GST exemption amounts are $12,060,000 per person, and the maximum federal estate, gift and GST tax rate is 40 percent. For 2023, the federal estate, gift and GST exemption amounts will be $12,920,000 per person (an $860,000 increase). The maximum federal estate, gift and GST tax rate will remain at 40 percent for 2023.
The combined estate and gift exemption amount represents the total amount of gifts each person can make during their lifetime, together with transfers allowed to be made by that person at death, without triggering any federal estate or gift tax. Thus, beginning on January 1, 2023, a married couple can transfer a combined $25,840,000 of property, free of federal estate and gift tax.
If an individual has already used their entire estate and gift tax exemption amount as of December 31, 2022, then such individual may make additional tax-free gifts in 2023, in an amount equal to $860,000 (i.e., the amount of the increase from 2022 to 2023). Similarly, a married couple with no exemption remaining as of the end of 2022 could make additional gifts in 2023 of $1,720,000 without incurring any federal estate or gift tax liability.
The GST tax exemption also increases to $12,920,000 per person as of January 1, 2023. GST planning commonly involves placing property into a trust during lifetime or at death and then allocating the GST tax exemption to such trust. GST trust planning generally allows for the property to remain in trust for future generations without triggering any federal estate, gift or GST tax on trust distributions to grandchildren or more remote descendants.
In addition to the amounts available via the federal estate, gift and GST exemptions, individuals are also entitled to make annual gifts through the use of their “annual exclusion amount”, without triggering any gift tax, or using any of their exemption. In 2022, the annual exclusion amount increased to $16,000, with an unlimited number of donees being allowed to be the beneficiary of such gifts. And because the annual exclusion amount is available to both spouses, in 2022, a married couple can gift up to $32,000 to as many donees as they like, without triggering gift taxes or using their lifetime gift exemption amount.
In 2023, the annual exclusion amount has increased again, and will be $17,000 per donee ($34,000 per donee for gifts made by a married couple). In light of the annual exclusion amounts available in 2022 and 2023, a consistent gifting program utilizing the annual exclusion remains a very viable and powerful planning tool for many taxpayers.
“Anti-Clawback” Guidance from the IRS
One issue which taxpayers and their advisors previously wrestled with was how the IRS would treat differences between exemption amounts in effect as of the date of a gift, and the exemption amounts in effect as of the date of a taxpayer’s death. The risk from a planning perspective was whether the IRS would attempt to “clawback” gifts which were covered by the exemption amount in effect as of the date of the gift, but exceeded the amount of the exemption that was available as of the date of a taxpayer’s passing.
Fortunately, the IRS, in Treas. Reg. 20.2010-1(c) provided that a taxpayer who takes advantage of their current lifetime gift tax exemption levels would not be penalized if the ultimate exemption amount available at the time of that taxpayer’s death was less than what was available at the time of the gift. Note: The IRS has recently proposed regulations that would allow for a “clawback” in certain limited circumstances the IRS views as “abusive”.
Unfortunately, the regulations do not permit gifts which are made during the time that the higher exemption amount is in effect to come “off the top”, and thus be applied against, the higher exemption amount after the exemption amount is lowered. Thus, when a taxpayer who has never made a taxable gift, completes a lifetime gift of $5,000,000 during the time that the higher exemption amount is available, and then passes away during a time when the exemption has decreased back to the pre-TCJA level, the lifetime gift will not be deemed to use the additional amount of exemption that was available to the taxpayer during their lifetime.
Planning
The split control of Congress brought about by the mid-term elections, when combined with the Biden administration’s failure to act (on a permanent basis) with regard to the federal estate, gift and GST exemption issue during their first two years in office, raises real questions about the ability of Congress to pass legislation to permanently deal with the exemption issue. Given this uncertainty, the looming sunset of the TCJA’s heightened exemption amounts, and a business environment that includes recessionary fears and thus corresponding lower business valuations, all combine for an excellent opportunity for taxpayers to use their increased exemption amounts during lifetime to their advantage. Because the IRS prohibits “off the top” allocation of the exemption, these lifetime gifts must exceed the amount of the pre-TCJA base exemption amount (adjusted for inflation) in order to take advantage of this opportunity. An additional benefit of the lifetime gift strategy is that future appreciation on the property that is gifted grows outside the taxpayer’s estate. Of course, the loss of an income tax basis “step up” must also be considered in connection with any significant planned gifts involving low basis assets.
A taxpayer’s specific circumstances must be taken into account when analyzing their estate, gift and GST planning program. Because a number of factors go into these significant taxpayer decisions, we encourage you to contact any member of the firm’s Tax and Estate Planning Practice Group for further guidance.
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