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Question:

In anticipation of either the current Biden proposal or 2026 change to reduce the estate tax exemption to $6 million per spouse, do gifts made PRIOR TO THE CHANGE go against the revised lower amount, the pre-change higher amount, or get pro-rated among the old (higher) and new (lower) amount? In other words, how can you best utilize the “disappearing” exemption?

Response:

As you know, the current $12 million federal estate and gift tax exemption ($24 million for a couple) will be cut in half for the estates of people dying in 2026 or later due to the sunsetting of the higher limits. (The sunsetting is the result of how the higher levels were enacted. They were part of the Trump-Ryan 2016 tax cut that had be be passed through budget reconciliation because it could not get a 60-vote majority necessary in the Senate for the new levels to become permanent.)

The good news for those individuals with extremely large estates is that they can in effect lock in the current federal estate and gift tax exemptions by making large taxable gifts. The IRS ruled in 2019 that gifts made under the current levels will be grandfathered and will apply to the current exemptions even if the taxpayer dies after these levels are cut in half in 2026 due to the higher levels sunsetting. Here’s a Wall Street Journal article that explains this quite well: https://www.wsj.com/articles/estate-and-gift-taxes-2020-2021-heres-what-you-need-to-know-11617908256.

But how does that really work? The answer is that if you make a really large taxable gift before the end of 2025 and die in 2026 or later, your federal estate tax exemption will be the larger of the amount of the gift and the federal estate tax exemption then in place. You won’t get to add the gift to the new exemption level. A couple of examples should explain this:

First, let’s assume you give away $2 million in 2025 and die in 2026. In that case, your exemption will be $6 million (adjusted for inflation). The $2 million taxable gift will count against this limit.

Second, let’s assume you give away $10 million in 2025, and die in 2026. In that case, your exemption will be $10 million. Of course, you will have used up that $10 million exemption through the lifetime gift, meaning everything left in your estate will be taxable (absent deductions, such as for money going to charity or to a surviving spouse).

Here’s an explanation on the IRS website: https://www.irs.gov/newsroom/estate-and-gift-tax-faqs.

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