We wrote recently about taking advantage of various strategies to make maximum use of the current, larger exemptions for estate and gift taxes before their potential reduction in size at the end of 2025. It bears repeating: In 2023, a married couple with an estate worth up to $25.84 million would be able to pass the entire estate to their heirs, in the event of their death, without incurring any federal estate or gift tax. In 2024, that number will increase because it is indexed to inflation, and the same will happen in 2025. But on December 31, 2025, unless legislation is enacted to extend it, the exemption will be cut roughly in half due to the “sunset” provision that is built into the Tax Cuts and Jobs Act (TCJA) of 2017.
For those with significant estates, it is prudent to take steps now that can position the estate for more favorable tax treatment in the event that the sunset provision goes into effect. This means taking maximum advantage of the lifetime estate and gift tax exclusion while it is still at the current, historically high level.
Understanding Your Lifetime Exemption
As its name implies, the lifetime exemption is the amount of money you can give away over the course of your life without having to pay gift or estate tax. The exemption is adjusted for inflation each year, as previously mentioned, and the gift and estate tax exemption are often lumped together as the “unified tax credit.” Though it has generally trended upward over time due to adjustment for inflation, the level of the exemption has varied significantly over the years, as shown by the following chart (values are for a single individual):
SOURCE: Internal Revenue Service
As the chart makes obvious, the exemption rose dramatically from 2017 to 2018 as a result of the passage of TCJA. It is expected to be somewhere in excess of $13 million ($26 million for a married couple) by 2025; if the sunset provision goes into effect, it will fall to around $6.5 million ($13 million for a married couple) at the end of 2025.
During your lifetime, you can give away up to 100% of your lifetime exclusion amount. When you pass your estate to your heirs, any amount above the exclusion becomes subject to estate tax.
It’s important to differentiate between what is meant by “lifetime exclusion” and “annual gift tax exclusion.” Each year, any person can give away a certain amount of money to one or more individuals without incurring gift tax or having to file a gift tax return. In 2023, that amount is $17,000 ($34,000 for a married couple). In 2024, the annual gift tax exclusion will rise to $18,000 ($36,000). You can give this amount to as many people as you wish without being required to file a gift tax return. As long as your annual gifts do not exceed the annual exemption level, they will not affect your lifetime exemption.
However, if you give more than the annual exclusion amount to any person, you must file a gift tax return. You may not have to pay gift tax, as long as the gift amount is less than your lifetime exemption. By filing the return, you may be able to apply the amount over the annual exclusion to your lifetime exemption, using your unified tax credit. But keep in mind: that amount will then be deducted from your lifetime exemption. Suppose, for example, that in the current year you give away $1 million to an individual. By filing a gift tax return, you apply the overage from your annual exclusion of $17,000 to your unified tax credit, reducing your lifetime exemption by $983,000 ($1 million – $17,000). Now, you have a remaining lifetime exemption (in 2023 dollars) of $11,937,000 ($12.92 million – $983,000).
For persons with significant assets who intend for their estate to pass to their heirs, it can make sense to utilize the currently high lifetime exemption to reduce the size of the taxable estate. As long as you retain enough to live comfortably, you can begin passing assets to your heirs without incurring estate or gift taxes.
Other Alternatives
But there are other ways to transfer larger amounts out of the estate without decreasing your lifetime exemption. For example:
- Accelerated gifting using a 529 plan. For grandparents who wish to fund education expenses for their grandchildren, the IRS offers a special provision for gifting up to five years’ worth of annual gifts to a 529 plan. The gifts are then deemed to be distributed over a five-year period, which means that the annual gift exclusion applies and the lifetime exemption remains unchanged. Even better, starting with the 2024–25 academic year, grandparent-owned 529 plans will not be considered as income for the student who is the beneficiary; this is advantageous for those who may also be applying for needs-based financial aid.
- Direct payment of medical or educational tuition expenses. The IRS grants an unlimited exclusion for gifts made for the payment of qualified medical expenses or educational tuition. The gift must not be for the benefit of the donor, and the funds must be given directly to the medical provider or educational institution, not to the person who is benefiting from the gift. As long as the gift meets these requirements, it can be of any size and no gift tax return is required. Such gifts also have no effect on the lifetime exclusion.
At Mathis Wealth Management, we want to make sure our clients have all the information they need to make smart decisions about taxation, investment, estate planning, and other vital financial goals. To learn more, visit our website to read our article, “Gifting Strategies You Can Use Now.”
Disclosure: Diversification is an investment strategy that can help manage risk within a portfolio, but it does not guarantee profits or protect against loss in declining markets. All investing involves risk and there is no guarantee that any strategy will ultimately be successful.
