2023 brings with it two big changes to tax provisions that could have a significant impact on your estate plan. Inflation adjustments for the federal gift and estate tax exemption amount and the annual tax exclusion for gifts are calculated annually, and this year's change shows how big of an effect inflation has had on the economy. But in this case, the result is a good one.
|Federal gift and estate tax applicable exemption amount||$12,060,000||$12,920,000|
|Annual exclusion for gifts||$16,000||$17,000|
It's important to remember, however, that the current federal estate tax exemption amount isn't permanent. The provisions of the Tax Cuts and Job Act (TCJA) that govern its level sunsets on December 31, 2025; after that date, it is set to fall back to its pre-TCJA level which, when adjusted for inflation, is currently estimated to be about $7 million per person.
For now, here are some things you may want to consider given the current exclusion amounts.
Small gifts can yield big results
While you may not expect a $34,000 (for married couples) gift to materially impact your wealth transfer goals, annual exclusion gifting year over year for long periods of time can have a big impact.
Say a couple with 3 children is planning gifts for each child through the end of the couple's life (for example, let's say 20 years). Using 2023's annual gift exclusion, they can give away $102,000 ($34,000 to each child, $17,000 from each parent) annually without incurring any gift tax or using any of their federal tax exemption.
As an example, if we assume a 7.5% compound annual growth rate on these gifts and an annual gift of $102,000 at the beginning of each year, this couple will have transferred about $2.04 million out of their taxable estate. That principal amount has the potential for $2.7 million in appreciation on those assets (provided the recipients do not spend any of the principal). Assuming a 40% tax rate (applied to assets in excess of the federal estate exemption available at death), gifting the assets annually could save approximately $1.9 million in federal estate taxes (40% of $4.74 million).
Not all gifts or transfers of assets qualify for the annual gift tax exclusion. Generally speaking, the recipient of the gift needs to have an immediate right to access and use the gifted assets. This requirement becomes an important consideration when gifting assets to an irrevocable trust for the benefit of children, for example. Families should work closely with a qualified attorney if they are considering making annual exclusion gifts to irrevocable trusts.
Don't overlook state estate taxes
Currently, 17 states have some form of estate or inheritance tax; Massachusetts and Oregon have the lowest state exemptions set at $1 million. If, for example, the couple in the previous example died as Massachusetts residents, 20 years of annual giving to the children could amount to state estate tax savings of approximately $758,000 ($4.74 million x 16%) using the top rate. Given these factors, it can be particularly impactful to utilize annual exclusion giving early and often if a client can afford to do so and the giving aligns with their wealth transfer goals.
An opportunity for greater lifetime gifting
With the rise of the federal estate tax exemption to $12.92 million in 2023, families that have utilized all of their lifetime exemption so far could transfer an additional $1.72 million (or $860,000 per spouse). With the additional $34,000 in annual gifting, the couples could add almost $2 million in additional assets in 2023.
Furthermore, gifting strategies can be combined with IRS-allowed valuation discounts that you may not have considered. For instance, subject to applicable conditions, you can create a family limited partnership (FLP) that manages and invests assets on behalf of your family. Typically, a parent serves as the general partner and creates limited partnership interests for their children. By utilizing their annual exclusion gift, the parent can transfer $17,000 of limited partnership interests to each of their children. The IRS typically allows the value of that interest to be discounted for a lack of control and other factors.
In-kind gifts of marketable securities can be appealing, as well. This is beneficial because a gift is valued at the time the gift is made. Gifting lower valued securities today means less gift tax liability for the donor and greater upside potential for the recipient if the securities are expected to appreciate over time. These types of gifts can be a powerful way to transfer assets out of your own estate even during a down market.
However, capital gains taxes could offset any potential estate and gift tax savings realized when gifting depreciated assets. In most cases, the cost basis of the gifted asset carries over to the recipient. When the recipient ultimately sells the appreciated asset, their capital gains liability will be based on the original owner's cost basis. It might be more beneficial to not gift the asset during lifetime and transfer the asset upon death, at which point the asset will receive a step-up in basis. It's important to be mindful of choosing the right securities when gifting them to your loved ones.
Consult with a professional
When developing a gifting strategy, especially involving entities like trusts or family limited partnerships, you should keep in mind the importance of working with a tax advisor and filing timely gift tax returns. While such returns will be handled by your CPA or tax attorney, you may also wish to involve an estate planner who can help you explore creative ways to take advantage of strategies that may help you further optimize your plan.
David is responsible for Fidelity's estate and wealth planning activities, including creation of new thought leadership in these areas. He heads a team of professionals that develops and delivers the depth and breadth of Fidelity's wealth planning offering.
Prior to joining Fidelity, David was managing director and head of Insured Solutions for UBS Wealth Management Americas. He served as chief operating officer of UBS Wealth Planning. David first joined UBS as a senior member of UBS Private Wealth Management, and was involved in the creation of that business for the firm. During his tenure with UBS, he also served as the chairman and president of UBS Life Insurance Company USA, Inc.; the chairman and president of UBS Financial Services Insurance Agency, Inc.; and a board member of UBS Trust Company, N.A.
Prior to joining UBS, David was a director in Merrill Lynch's Private Banking & Investment Group. He joined the firm's International Private Banking business in London and was a key member of the firm's Corporate Strategy unit.