Magic 8-ball guesses about estate tax exemption amount

[SecondCor521]

Hi all.

I am interested in what your magic 8-ball says about the estate tax exemption amount over the next five years.

The current amount is $11.58M per person. This amount is scheduled to increase by inflation until 2026, when it will drop back down to $5M plus inflation.

There is a policy proposal to reduce it to $3.5M per person.

The IRS has permitted use of larger exemption amounts if gifting is done earlier in life. See https://www.irs.gov/newsroom/estate-and-gift-tax-faqs first item: "Making large gifts now won’t harm estates after 2025".

I know we can't predict the future. But I think there may be wisdom in crowds. (I suppose there could be madness in crowds as well, but probably not in this context.)

I am particularly interested in information about whether any reduction in the exclusion amount will have any sort of advance notice, and whether people think the "Making large gifts now won’t harm estates after 2025" paradigm will continue to remain in place or will be eliminated.

This is germane to the ER forum because some here face estate tax issues, and estate tax planning and information can affect FIRE for subsequent generations.

Please keep politics out of the discussion.

Thank you.

 

[Koolau]

Well, the treasury is gonna need a lot of money to cover the costs incurred due to Covid. Willie Sutton suggested going where the money is. I'll stop there since YMMV.

 

[target2019]

I agree with proposal "for the estate and gift tax lifetime exemptions to return to year 2009 levels which are $3.5 million estate and $1 million gift with an increased maximum tax rate of 45%."

But it is likely that something else will eventually be negotiated for tax changes overall. The debt will be reduced.

 

[RetireeRobert]

The only thing my magic eight ball tells me is: "taxes will change."

 

[Montecfo]

My guess would be we got to $5m when current law lapses and no changes before.

I think it would be really hard to pass something draconian like $1m limit. I think tax increases will be hard to pass with high employment.

As far as the current gift tax thresholds, all taxpayers can do is rely on current guidance. I do not see a retroactive tax there.

Those are my thoughts.

 

[Koolau]

The only thing my magic eight ball tells me is: "taxes will change."

I agree. I think we'll also find all those folks who were screaming "Tax the Rich" will wake up and realize that they ARE the rich. The new battle cry will become "Tax the Richer Than Me." YMMV

 

[RetireeRobert]

I agree. I think we'll also find all those folks who were screaming "Tax the Rich" will wake up and realize that they ARE the rich. The new battle cry will become "Tax the Richer Than Me." YMMV

Bingo!

 

[RunningBum]

So there are two issues here:
- What might the future estate exemption be?
- How do you use the special rule?

Starting with the special rule, if one had $100M, it might be worth gifting $11.8M now, leaving 88.2M (plus increases) subject to estate tax, assuming you don't have another way to shield it. If you don't take advantage of the special rule and kept all gifts under $15K, $95M or $96.5M (less inflation) would be subject to the estate tax.

On the other hand, if you had just $6M, giving away $5M now does not help you at all if the future estate exemption is $5M, and you have also drastically cut your own net worth in the process. Even if the exemption is $3.5M, you shielded an extra $1.5M but really shorted yourself in the process.

If it even affects me, I'm much more likely to fall into something like the $6M situation than the $100M situation.

Given that, I'm not going to worry much about the future exemption amount. My prediction would be that it reverts to $5M plus inflation which happens with no legislative change, rather than a further reduction, or eliminating the sunset provision and keeping it at $11.8M + inflation.

Am I understanding that special rule correctly?

And could we please leave out the nonsense YMMV posts? They add nothing to the discussion and drift towards politics.

 

[38Chevy454]

I believe it will fall back to the preset $5M limit built into current law. That way no politician has to go on record as formally voting for a tax increase. They just let the current law expire. Gov't will need more money to service ever increasing debt, which payments will only get worse as interest rates increase.

I don't agree with class warfare and the "tax the rich" or whatever words are used. Even if I am not affected by the $5M limit, it goes against my belief to tax estates on something that was previously paid tax on. I know the stepped up basis is under attention now and is also one of the targets.

 

[SecondCor521]

So there are two issues here:
- What might the future estate exemption be?
- How do you use the special rule?

[...]

Am I understanding that special rule correctly?

I'm not sure. I've read the special rule multiple times and think I understand it. But here's sort of the nut of my question:

Suppose a taxpayer has $12M today. They give away $8M in 2024. The sunset happens in 2026. They die in summer 2026 with $4M.

Which is true:

1. They pay no gift tax on the $8M because it was under the ~$12M limit in 2024. They pay no estate tax in 2027 because their estate is under the $8M limit by virtue of the special rule (limit is greater of limit in effect at death or lifetime giving earlier).

2. They have to pay some taxes somehow because the limit in 2027 might be $6M and they had $12M to start with and $12M > $6M.

After a lot of careful reading, I think it's the former, but that seems a little too nice of the IRS. I think I must be missing something.

So the way *I* would think about using the special rule is as follows:

1. Monitor my estate value and the current limit as well as governmental action in this area.

2. If the limit is about to drop, give away enough to get my estate below the limit before it drops, keeping enough to meet my needs of course.

3. Try to stay below the limit until I die or the limit gets raised again.

(NB: I don't have $12M.)

 

[DrRoy]

What arrangement do you have to have for both spouses' exemptions to carry over to the last surviving spouse?

 

[Sunset]

What arrangement do you have to have for both spouses' exemptions to carry over to the last surviving spouse?

I saved this info, perhaps it's what you are looking for:

For example, if Bob and Sally are married and Bob dies in 2011 and only uses $3,000,000 of his $5,000,000 federal estate tax exemption, then Sally can elect to pick up Bob's unused $2,000,000 exemption and add it to her estate tax exemption. Assuming that Sally has not used any of her estate tax exemption for lifetime gifts and makes the portability election, then Sally will have a $7,250,000 exemption in 2013 (Bob's unused $2,000,000 exemption plus Sally's $5,250,000 exemption = $7,250,000 exemption).


So how does Sally go about making the election to use Bob's unused estate tax exemption? For a surviving spouse to properly make the election to use the deceased spouse’s unused estate tax exemption, the surviving spouse must timely file IRS Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. Form 706 is due on or before nine months after the deceased spouse’s date of death; however, an automatic six-month extension can be requested by filing an IRS Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes, on or before the due date for Form 706.




Note: On February 17, 2012, the IRS released Notice 2012-21, which provides that for certain estates, the portability election can be made within 15 months after the date of death even if the surviving spouse failed to timely file a Form 4768.

 

[SecondCor521]

What arrangement do you have to have for both spouses' exemptions to carry over to the last surviving spouse?

In the cases I'm concerned about, there is no spouse.

But if there were, I'd timely file the form to elect the DSUEA. The DSUEA is mentioned in the anti-clawback rules, and there are interactions between the two, but honestly I didn't fully read or understand them since they didn't apply. (Roughly speaking it appears that the DSUEA gets used up before the BEA is applied.)

Or do a marital bypass trust, as was necessary in Ye Olden Days.

 

[audreyh1]

I'm not sure. I've read the special rule multiple times and think I understand it. But here's sort of the nut of my question:

Suppose a taxpayer has $12M today. They give away $8M in 2024. The sunset happens in 2026. They die in summer 2026 with $4M.

Which is true:

1. They pay no gift tax on the $8M because it was under the ~$12M limit in 2024. They pay no estate tax in 2027 because their estate is under the $8M limit by virtue of the special rule (limit is greater of limit in effect at death or lifetime giving earlier).

2. They have to pay some taxes somehow because the limit in 2027 might be $6M and they had $12M to start with and $12M > $6M.

After a lot of careful reading, I think it's the former, but that seems a little too nice of the IRS. I think I must be missing something.

So the way *I* would think about using the special rule is as follows:

1. Monitor my estate value and the current limit as well as governmental action in this area.

2. If the limit is about to drop, give away enough to get my estate below the limit before it drops, keeping enough to meet my needs of course.

3. Try to stay below the limit until I die or the limit gets raised again.

(NB: I don't have $12M.)

I believe it is 1.

 

[SecondCor521]

Thanks audreyh1!

I think it would still be 1 even if the circumstances were starting with $6M, giving away $2M in 2024, and dying with $4M in summer 2026. The only difference would be that the estate tax limit would be the $5M plus inflation BEA instead of $8M as in the previous case.

(I think the concern I had was that the IRS rules would somehow retroactively tax the $8M or $2M in gifts, but I guess that's the whole point of the anti-clawback rule. So from that point of view it makes sense that the rule works the way it does.)

Also, forgot to mention it before, but in all cases of course a properly completed Form 709 would be timely filed in all examples and in real life.

 

[EnricoPallazzo]

I'm not sure. I've read the special rule multiple times and think I understand it. But here's sort of the nut of my question:

Suppose a taxpayer has $12M today. They give away $8M in 2024. The sunset happens in 2026. They die in summer 2026 with $4M.

Which is true:

1. They pay no gift tax on the $8M because it was under the ~$12M limit in 2024. They pay no estate tax in 2027 because their estate is under the $8M limit by virtue of the special rule (limit is greater of limit in effect at death or lifetime giving earlier).

2. They have to pay some taxes somehow because the limit in 2027 might be $6M and they had $12M to start with and $12M > $6M.

After a lot of careful reading, I think it's the former, but that seems a little too nice of the IRS. I think I must be missing something.

I'd say #1 as well. It looks like the page you linked (https://www.irs.gov/newsroom/estate-and-gift-tax-faqs) has a similar example:

Q. How does the special rule work?
A. Here’s an example. Before 2018, A had never made a taxable gift. In 2018 when the BEA [basic exclusion amount] is $11.18 million, A makes a taxable gift of $9 million. A uses $9 million of the available BEA to reduce the gift tax to zero. A dies in 2026. Even if the BEA is lower that year, A’s estate can still base its estate tax calculation on the higher $9 million of BEA that was used in 2018.

 

[audreyh1]

(I think the concern I had was that the IRS rules would somehow retroactively tax the $8M or $2M in gifts, but I guess that's the whole point of the anti-clawback rule. So from that point of view it makes sense that the rule works the way it does.)

Also, forgot to mention it before, but in all cases of course a properly completed Form 709 would be timely filed in all examples and in real life.

Exactly! Otherwise only people who died in the years of the higher exemption would be able to use it, and no one alive could give gifts against the current estate exemption.

I think I remember seeing lists of years and exemptions in the 709 worksheet, so I think it’s already set up for that.

 

[RunningBum]

I think it would still be 1 even if the circumstances were starting with $6M, giving away $2M in 2024, and dying with $4M in summer 2026. The only difference would be that the estate tax limit would be the $5M plus inflation BEA instead of $8M as in the previous case.

This is the case I'm not sure about. Would the estate of the person who gave away $2M and died with $4M still owe tax on $1M (if the BEA were $5M)? Or would the estate owe $0 tax because the $2M was under the higher limits, and the remaining $4M under the time of death exemption of $5M

 

[cathy63]

I'm not sure. I've read the special rule multiple times and think I understand it. But here's sort of the nut of my question:

Suppose a taxpayer has $12M today. They give away $8M in 2024. The sunset happens in 2026. They die in summer 2026 with $4M.

Which is true:

1. They pay no gift tax on the $8M because it was under the ~$12M limit in 2024. They pay no estate tax in 2027 because their estate is under the $8M limit by virtue of the special rule (limit is greater of limit in effect at death or lifetime giving earlier).

2. They have to pay some taxes somehow because the limit in 2027 might be $6M and they had $12M to start with and $12M > $6M.

After a lot of careful reading, I think it's the former, but that seems a little too nice of the IRS. I think I must be missing something.

So the way *I* would think about using the special rule is as follows:

1. Monitor my estate value and the current limit as well as governmental action in this area.

2. If the limit is about to drop, give away enough to get my estate below the limit before it drops, keeping enough to meet my needs of course.

3. Try to stay below the limit until I die or the limit gets raised again.

(NB: I don't have $12M.)

This is a pretty good explanation of the rules: https://www.journalofaccountancy.com/news/2019/nov/irs-estate-gift-tax-clawback-rules-201922516.html. It also has a link to the officiall IRS final regs.

My understanding from this is that the BEA used for tax calcs will be the maximum of the BEA in effect when the taxpayer dies or the amount previously sheltered legally. So, suppose the BEA in 2026 is $5M. For a single person who has given away $8M in 2024 and dies with $4M in 2026, the estate's BEA will be $8M; but all of that has already been used by the previous gift. Therefore, the estate owes taxes on $4M.

 

[audreyh1]

This is a pretty good explanation of the rules: https://www.journalofaccountancy.com/news/2019/nov/irs-estate-gift-tax-clawback-rules-201922516.html. It also has a link to the officiall IRS final regs.

My understanding from this is that the BEA used for tax calcs will be the maximum of the BEA in effect when the taxpayer dies or the amount previously sheltered legally. So, suppose the BEA in 2026 is $5M. For a single person who has given away $8M in 2024 and dies with $4M in 2026, the estate's BEA will be $8M; but all of that has already been used by the previous gift. Therefore, the estate owes taxes on $4M.

Yes, from a couple of things I have read, this will be the case.

So, the larger gifts during a period of higher exemption can’t drive the estate exemption negative (meaning you owe something on the prior gifts), but it can drive the remaining exemption to zero, meaning that you owe something on the remaining estate.

 

[SecondCor521]

My understanding from this is that the BEA used for tax calcs will be the maximum of the BEA in effect when the taxpayer dies or the amount previously sheltered legally. So, suppose the BEA in 2026 is $5M. For a single person who has given away $8M in 2024 and dies with $4M in 2026, the estate's BEA will be $8M; but all of that has already been used by the previous gift. Therefore, the estate owes taxes on $4M.

Emphasis added.

That's sort of the point I was wondering about.

I was hoping that the earlier gift (of $8M or $2M) were sheltered as avoiding gift taxes because they were under the BEA at the time. They were also exempt from estate taxes because they would have been out of the estate. Then the remaining $4M was sheltered from estate taxes because they were under the anti-claw back BEA (of $8M or $5M) at that later time. The latter amount would have been exempt from gift tax because it was not gifted.

I know that the gift taxes and estate taxes are unified, but I didn't know how unified they were and how this claw back rule works. I've tried reading all of the links but they're not very precisely written and none of the examples apply to the situation that I'm curious about (which is in the vein of the second example on this thread).

 

[cathy63]

Emphasis added.

That's sort of the point I was wondering about.

I was hoping that the earlier gift (of $8M or $2M) were sheltered as avoiding gift taxes because they were under the BEA at the time. They were also exempt from estate taxes because they would have been out of the estate. Then the remaining $4M was sheltered from estate taxes because they were under the anti-claw back BEA (of $8M or $5M) at that later time. The latter amount would have been exempt from gift tax because it was not gifted.

I know that the gift taxes and estate taxes are unified, but I didn't know how unified they were and how this claw back rule works. I've tried reading all of the links but they're not very precisely written and none of the examples apply to the situation that I'm curious about (which is in the vein of the second example on this thread).

The way Form 706 works is roughly*:
1) Add the net estate value and all prior taxable gifts
2) Calculate the estate tax on that entire amount and subtract any gift taxes paid in prior years = $X
3) Determine the exclusion amount
4) Calculate the estate tax on the exclusion = $Y
5) If $X > $Y, then tax owed is $X - $Y, else tax owed is $0.

I think we might be making things more confusing by worrying about what's sheltered and what's in or out of the estate. In order to calculate the estate tax, you always have to include all the gifts that were (or should have been) reported on gift tax returns while the decedent was alive, and that shouldn't change in the future.

The real question is how will the IRS determine the exclusion amount in future years. I agree that it's not entirely clear, but the way I read the rules that have been issued so far, I think BEA will have to be calculated from the decedent's prior gift tax returns rather than just looked up in a table based on the year of death, as it is now. What I understand is that if you've given away more than whatever is the current BEA when you die, but the cumulative amount was always at or below the BEA for each year during which you made gifts, then your personal BEA will be actual amount you gave away.

So for the examples you gave earlier:
- where the decedent gave away $8M in 2024 and he dies in 2026 with $4M while the default BEA is $5M, the decedent's BEA will be $8M. The executor will fill out form 706 and calculate the tax on $12M and subtract the tax on $8M (mathematically it's the same as just calculating the tax on $4M), which is $1.6M.
- where the decedent gave away $2M in 2024 and he dies in 2026 with $4M while the default BEA is $5M, the decedent's BEA will be $5M. In this case, the tax is .4 * ($4M + $2M - $5M) = $400K

The "no clawback rule" just means that the BEA for the first example won't be limited to $5M.


*There are rules about property transferred shortly before death, deductions for state and foreign estate taxes, charitable bequests, spouse's unused exemptions, split gifts, etc, etc, but let's just ignore all of those for now.

 

[RunningBum]

^^
That's how I read it too. The idea is that they won't claw back estate taxes if you exceeded the current estate exemption but at the time of the gifts it was under the exemption at the time. That's all.

What they aren't covering is any notion of shielding anything extra when you previously made some taxable gifts under a larger exemption, but those gifts do not exceed the current exemption.

 

[Montecfo]

It does seem to be a fair approach.

 

[SecondCor521]

Thanks for all the replies and comments.

I have great respect for @cathy63's knowledge and have seen at least one professional article somewhere supporting her description in post #22.

I'm not concerned with notions of fairness (post #24). At the moment I'm concerned with understanding the rules in order to help implement the best strategy for the situation I'm familiar with.

The takeaways I have at the moment, assuming post #22 is accurate:

1. While the rule is written simply and is therefore just a rule, the effects in its implementation vary conceptually: the $8M More Aggressive Gifter (MAG) is effectively taxed on their "leftover estate" of $4M and not at all on their earlier gifting whereas the $2M Less Aggressive Gifter (LAG) is effectively taxed on their "total starting estate" of $6M.

2. The LAG really has very little incentive to take advantage of the currently higher exclusion amount. They get taxed on $6M whether they gift or not (well, except any gains on their earlier gifting does end up in the recipient's estate, so I guess there is that), and gifting earlier just may raise concerns in their mind of keeping enough for themselves.

3. The MAG benefits, but not as much as it may first appear. For giving away $8M, they only grow their BEA by $3M (because they'd get the $5M BEA anyway if they did nothing).

@cathy63, do you know if these new rule modifications are embodied in the current estate tax instructions somewhere? And if so, specifically where? I'm going to go look, but I'm not very familiar with the document and it's easy to overlook or miss things of this nature.