What Will Happen When the Gift and Estate Tax Exemption Gets Cut in Half?
Although the vast majority of Americans have estates that fall under the estate and gift tax exemption, the exemption is set to be cut in half in 2026. Proper planning may be necessary to make sure you are taking full advantage of the current exemption and aren’t negatively affected when it decreases.
The federal estate tax lifetime exemption increased to $12.92 million per person in 2023. A single person with less than this amount of assets at his or her death will not be required to pay estate tax. Fewer than 1 percent of households in the United States have assets totaling more than $10 million, and married couples can double these thresholds. So even fewer American families have a net worth exceeding $25.84 million.
However, the law setting the this exemption amount will sunset at the end of 2025. Unless Congress acts in the interim, for those dying in 2026 or later the threshold will be $6.8 million, adjusted for inflation between now and then. This sunset raises the question as to what happens if a taxpayer makes a taxable gift before 2026 when the threshold is $12.92 million or more, but dies after 2026 when the threshold has been cut in half. Fortunately, the IRS has answered this question.
How Gift Taxes Work
The annual gift tax exclusion is $17,000 (in 2023). This means that each year you can give $17,000 to as many individuals as you like — and neither you nor the recipient have to report the gifts to the IRS. But if you give anyone more than that amount in a single calendar year, you are supposed to report the excess on a gift tax return. (The recipient still does not have to report it.) Your reported lifetime gifting reduces your lifetime exemption. If your reported lifetime gifting exceeds your lifetime exemption, you will owe gift tax on the surplus.
An example should help clarify this. If you give your brother $1.017 million, in 2023 you will have to report a taxable gift of $1 million. This means that if you pass away before 2026, your estate tax threshold will be $11.92 million instead of $12.92 million. There’s still a lot of cushion there, which is why in practice very few people really have to worry about estate taxes.
Pre-2026 Gifts and Post-2026 Estates
But what happens if you die in 2026 or later? The answer is that, in this example, the credit that will be applied for purposes of determining your estate’s tax liability will be based on the $6.8 million exclusion amount in 2026, or on the exclusion in effect as of the date of your passing. Unfortunately, you will not get the benefit of the $12.92 million exclusion that was in effect when you made the gift in 2023.
So, for many taxpayers who die in 2026 or later, their estate taxes will be computed as if the higher threshold never existed, unless they made larger gifts covered by an exclusion in effect at the time of the gift. In that case, an estate can still base its estate tax calculation on the higher basic exclusion amount that was in effect.
So, for instance, if you had been more generous to your brother, you may have given him $10.017 million in 2023 instead of $1.017 million. If you then died in 2026 or later, the $10 million taxable gift would be your new estate tax threshold instead of $6.8 million. Everything else in your estate would be subject to tax, but the $10 million you gave your brother would still be gift and estate tax-free.
In other words, the IRS has ruled that, beginning in 2026, your estate tax threshold will be the greater of the estate tax threshold then in place or the total taxable gifts you have made during life.
Consult With a Professional
There are exceptions to the foregoing that may apply (if, for example, a spouse elects portability of a deceased spouse’s unused estate and gift tax exclusion). However, this is beyond the scope of this article.
If you are affected by these rules, don’t try taking any tax planning steps on your own. Without proper planning, the estate tax savings may be overwhelmed by the increased taxes on capital gains incurred by the gift recipient. Contact us to discuss your estate planning and lifetime gifting strategy.