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Planning With the Increased Exemption Amounts While They Last

Berdon Tax Team

12.8.22 | Client Alert

Estate, Gift, and Generation-Skipping Transfer Tax Considerations

The 2017 Tax Cuts and Jobs Act (TCJA) included increased estate, gift, and generation-skipping transfer (GST) exemptions that resulted in more opportunities for estate and gift planning. These increased exemptions, which are adjusted annually for inflation, are scheduled to expire at the end of 2025. Due to the rising cost of living, the 2023 tax year will reflect significant inflation adjustments to these exemptions. The chart below summarizes the timeline of Estate, Gift, and GST exemptions starting in 2017 through 2022, as well as the scheduled increase for 2023.

Estate and Gift

Planning Opportunity

With these increases come plenty of planning opportunities to shield significant wealth from the dreaded estate tax. Due to inflation adjustments, the 2024 exclusion amount is anticipated to increase significantly, and by January 2025, the exclusion amount is projected to be about $14,000,000 ($28,000,000 for a married couple). For those taxpayers that have not made taxable gifts since 2021, there may be an opportunity to make additional gifts in excess of $2,000,000 ($4,000,000 for a married couple) by the end of 2025.

Further, under final IRS regulations, taxpayers can make gifts under the TCJA increased exemptions without concern that these gifts would be clawed back if they die in 2026 or later when exemptions return to $5,000,000 (indexed for inflation). Taxpayers should be proactively meeting with their estate advisors to come up with a plan to utilize these exemptions by the end of 2025.

Annual Gift Exclusion

The annual gift exclusion is the maximum amount an individual can give to another individual in any given year without any estate or gift tax consequences. The annual gift exclusion, which is in addition to the lifetime gift exemption, is currently $16,000 per person ($32,000 for a married couple), scheduled to increase to $17,000 ($34,000 for a married couple) in 2023. It is expected to further increase in 2024.

Gift Planning Irrespective of Rising Interest Rates

The Internal Revenue Service (IRS) publishes monthly Applicable Federal Rates (AFRs), which is the minimum rate a lender can charge when calculating interest between related parties. Gifts that require calculating the present value of an annuity, an interest for life or term of years, or a remainder or reversionary interest require the use of the section 7520 rate, which is 120% of the mid-term AFR.

Below is a comparison of the AFRs as of December 2021 versus December 2022 (based on annual interest payments):

December 2021
December 2022
Short-Term AFR (loan up to 3 years)
Mid-Term AFR (loan over 3 years, up to 9 years)
Long-Term AFR (loan over 9 years)
Section 7520 Rate (120% Mid-Term AFR rounded up)

Historically, the short-term AFR has been the lowest rate, resulting in estate planning using loans less than three years with the anticipation of refinancing when the loan came due. Currently, the mid-term and long-term AFRs are lower than the short-term AFR, allowing for planning using longer-term loans. This mitigates the risk of having to refinance within three years when it is unknown where the AFR will be.

Planning Opportunities

Although rates have been steadily increasing, there are still tremendous planning opportunities to leverage the increased exemption. A common planning strategy is to structure a transfer as a partial gift/partial sale to an irrevocable grantor trust whereby the grantor takes back an AFR note for the sale portion. The appreciation of the assets will grow estate tax free. Additionally, for transfers of fractional interests, valuation discounts may be available. Further, an irrevocable grantor trust is often structured so that the grantor pays the income taxes associated with the income generated from the grantor trust assets so that the assets grow in the trust income tax free.

For those clients that are concerned with losing control of certain assets, they may choose to set up a spousal lifetime access trust (SLAT). These are irrevocable grantor trusts that include the grantor’s spouse as a beneficiary. SLATs provide the grantor’s spouse access to the trust assets.

Asset Swaps

Currently, assets includable in an estate are taxed based on their fair market value as of date of death, and the basis of the estate assets get a step-up or step-down in value. This results in no income tax assessed on the built-in gain of assets held in a person’s estate at death. Due to the basis step-up, older individuals often look to retain their low-basis assets in their estate. Individuals have the ability to accomplish this by swapping out low basis assets held in a grantor trust with high-basis assets that are includable in their estate. This can be done if their grantor trust agreement includes a swap power, or if there is no trust swap power, it can be done through a sale. The assets are swapped in equal amounts of fair market value at the time of the swap.

Planning Opportunity

Low-basis estate assets that have depressed in value and are expected to rebound in the future are ideal for swaps.

State Considerations – Connecticut and New York

New York Estate Tax

While New York residents are not subject to a state-level gift tax, the state does have an estate tax. As of January 1, 2023, the NYS estate exemption is estimated to increase to $6,540,000. This is almost half of the federal estate exemption. NYS residents should be thinking about the large estate exemption discrepancy when planning to gift assets in trust during their lifetime. Gifts made while a NYS resident would not be subject to any state gift tax, while assets transferred post-death that exceed state exemptions would be subject to a state estate tax, on top of any federal estate tax. The current maximum NYS estate tax rate is 16%. Therefore, a NYS resident estate may pay up to a combined federal and state estate tax rate of 49.6%.

The NYS estate tax exemption begins to phaseout at values over a certain threshold ($6,540,000 estimated for 2023), with the complete phaseout of the exemption for estates valued more than 105% of the then-existing NYS exclusion amount. In 2023, estates valued higher than $6,867,000 ($6,540,000 x 105%) will be subject to NYS estate tax, on the entire estate. The phaseout of the exemption makes it beneficial for NYS residents to gift assets during their lifetime to avoid any unwarranted NYS estate tax.

Planning Opportunity

NYS residents in the later stages of their estate planning should consider the NYS three-year “clawback” rule when gifting assets. Any lifetime gifts made within three years of death are added to the decedent’s NYS estate tax calculation. Gifts made prior to three years, made on or after January 1, 2026, or made during a time when the decedent was not a resident of NYS are not included in the addback.

Connecticut Estate and Gift Tax

Connecticut is the only state that has a gift tax. When the TCJA was enacted, Connecticut did not raise its estate and gift tax exemption to follow the federal amounts. As a result, CT residents have encountered a challenge in maximizing the federal exemption due to lower CT amounts. Gifts of tangible property located outside the state of CT are exempt from CT gift tax; therefore, CT residents often gift property located outside CT to avoid paying a CT gift tax. Beginning January 1, 2023, the CT lifetime estate and gift exemption is scheduled to reset to Federal levels at $12.92M, up from $9.1M in 2022.

Planning Opportunity

In 2023, if a grantor trust has a swap power, residents that formerly gifted property located outside of CT may have the opportunity to swap out those assets without incurring CT gift tax.

Revisiting Your Estate Planning Documents

Individuals should be reviewing their estate planning documents regularly to ensure the overall estate plan still makes sense, including named executors and trustees, and designated beneficiaries of retirement accounts and life insurance.

Planning Opportunity

Individuals should be actively updating their estate liquidity analysis to have a plan in place for the payment of estate taxes. This includes using life insurance policies that may provide liquidity to pay estate taxes.

There are many considerations and planning opportunities as we get close to the end of 2022 that should be considered with the adjustments coming in 2023. If you have questions or would like to further discuss your gift and estate planning, contact Scott Ditman at 212.331.7464 | sditman@berdon.com, Veronique Horne at 212.331.7631 | vhorne@berdon.com or Jessica Woolley at 212.324.3360 | jwoolley@berdon.com or reach out to your Berdon tax advisor.