The proposals in early versions of the Build Back Better Act had estate planners and American taxpayers on edge throughout 2021. While 2022 is well under way with no major legislative activity impacting gift and estate taxation, the sun continues to set on the $10 million estate tax basic exclusion amount under the temporary provisions of the Tax Cuts and Jobs Act of 2017.
Now is the time to consider the 2022 updates to the tax laws and review your estate plan with an eye toward tax planning opportunities in the years ahead.
The Internal Revenue Code allows each person to transfer a certain amount of assets over the person’s lifetime and at death, free from federal estate tax. That amount – referred to under the Code as the basic exclusion amount – was temporarily increased under the Tax Cuts and Jobs Act from $5 million to $10 million, and is adjusted every year for inflation. For 2022, the basic exclusion amount increased to $12.06 million, up from $11.7 million in 2021.
The United States imposes a gift tax on transfers over a certain value in a single year to an individual recipient. The amount that may be transferred as a gift to an individual in any given year free from gift tax is referred to as the annual exclusion amount. After four years without an increase, the annual exclusion amount has increased to $16,000 for transfers occurring in 2022.
That means that an individual can transfer up to $16,000 per person to as many individual recipients as the person wishes, without any requirement to pay gift tax or even file a gift tax return. If a person makes a gift to an individual recipient exceeding the annual exclusion amount, a gift tax return must be filed for the year the gift is made. Upon the filing of a gift tax return, the person making the gift must either (1) pay any gift tax due, or (2) use up a portion of the individual’s lifetime exemption from estate tax, rather than paying gift tax.
Generation-Skipping Transfer Tax
In addition to estate tax, the United States imposes a separate but related tax on transfers made to so-called “skip persons.” In simplified terms, a “skip-person” is a person who is two or more generations younger than the taxpayer (i.e. a grandchild, great-grandchild, etc.). Recipients unrelated to the taxpayer are generally considered skip-persons if they are more than 37 ½ years younger than the taxpayer making the transfer. Similar to the federal estate tax, each person has a lifetime exemption from generation-skipping transfer tax. For 2022, the lifetime exemption from generation-skipping transfer tax is $12.06 million.
Maine Estate Tax
Some states, including Maine, impose a separate state estate tax. Like the federal estate tax, each estate subject to Maine estate tax is afforded a lifetime exemption, which is adjusted annually for inflation. For 2022, the Maine lifetime exemption from estate tax is $6,010,000 per person. While the Maine lifetime exemption is lower than the federal exemption, the highest applicable tax rate of 12% is considerably lower than the highest applicable federal estate tax rate of 40%.
Planning Opportunities for 2022 and Beyond
Absent further legislative action, the federal estate tax basic exclusion amount is scheduled to return to $5 million (adjusted for inflation) at the end of 2025. There are a number of planning opportunities that should be considered now in anticipation of lower estate tax exemptions in the near future.
1. Elect Portability for Individuals Dying Between 2018 and 2025
Married couples have an advantage when it comes to the federal estate tax exemption. If the first spouse to die does not use up that spouse’s lifetime exemption from estate tax (for example, because the entire estate passes to the surviving spouse under the unlimited marital deduction – a special rule that allows an individual to transfer an unlimited amount to the individual’s surviving spouse free from any gift or estate tax), an election may be made to transfer the deceased spouse’s unused exemption to the surviving spouse. As a result, the surviving spouse gets to use the spouse’s own exemption plus the deceased spouse’s exemption, which allows the surviving spouse to pass a significantly higher amount to the couple’s heirs free from estate tax.
The transfer of one spouse’s unused estate tax exemption to the surviving spouse is an election referred to as “portability.” The election must be made on a federal estate tax return for the first deceased spouse’s estate. Estate tax returns must generally be filed within 9 months of a decedent’s death, but there are special rules that may allow for the late filing of a return for purposes of electing portability.
With the estate tax exemption set to decrease in 2026, there may be significant benefit to filing a return to elect portability of the unused exemption of individuals dying between 2018 and 2025. (Note: portability is not available for the Maine state estate tax exemption. Be sure to separately discuss state-specific estate tax planning alternatives with your estate planner.)
2. Gift Now to Maximize Current Exemptions
In 2019, the Internal Revenue Service clarified that individuals making transfers between 2018 and 2025 in reliance upon the then-existing estate and gift tax exemptions will not be penalized later if the exemptions drop back to the pre-Tax Cuts and Jobs Act levels. In light of that guidance, high net worth individuals may want to consider making large gifts now to take advantage of the current increased exemption amount. Significant gifting should only be completed with the advice of your tax professionals and your estate planning attorney.
3. Reduce the Taxable Estate
One simple and perhaps obvious way to reduce the amount of tax that may be due on death is to reduce the value of the taxable estate. That may be accomplished in a number of ways. Here are some opportunities you may wish to consider with your advisors:
- Take advantage of the annual gift tax exclusion to make annual tax-free gifts to intended beneficiaries. Recall that an individual may make gifts of up to $16,000 per person, per year, to as many different beneficiaries as the person wishes. Doing so will reduce the amount that is left to pass upon the individual’s death, thus decreasing the amount of estate tax that may otherwise be due.
- Take advantage of the unlimited charitable deduction. Gifts to charity – whether made during life or upon death – are not subject to federal gift or estate tax. Individuals who are charitably inclined should consider ways to incorporate charitable giving into their estate plans. Giving to charity during life may have both estate and income tax benefits for the donor.
- Pay medical or educational expenses for your family or other beneficiaries. Payments made directly to a health care provider or educational institution are exempt from federal gift and estate tax, with no limitation on the amount that may be gifted for such purposes. Paying a grandchild’s tuition or helping a family member with extraordinary medical expenses may be an easy way to reduce exposure to gift and estate tax. (Note: be sure that payments are made directly to the provider of services. Payments made to the beneficiary are not exempt, even if the beneficiary can prove the funds received were applied toward medical or educational expenses.)
- Consider additional advanced estate tax planning strategies, such as certain types grantor trusts, to leverage valuation discounts and remove from the taxable estate assets that are likely to appreciate over time.
Estate, gift, and generation-skipping transfer tax laws are constantly changing, so regular review of your estate plan is critical to maintaining a tax-efficient plan for the transfer of your assets. A team of advisors can assist you in preparing a flexible plan that meets your estate planning goals while minimizing tax exposure.
Contact Kristy or another one of our estate planning attorneys to add them to your trusted team.
Kristy Hapworth, Esq.