The 2017 Tax Cuts and Jobs Act (TCJA) brought a unique estate planning opportunity by creating a temporary "bonus" exclusion, which doubled the gift and estate tax exclusion for individuals. Prior to the TCJA, an individual was allowed a unified gift and estate tax exclusion amount equal to $5 million (as adjusted annually for inflation).
With the current TCJA, an individual is now allowed a unified gift and estate tax exclusion amount equal to $10 million (as adjusted annually for inflation). In 2022 this amount is $12.06 million. This means that an individual can make $12.06 million of lifetime gifts free of federal gift tax or their estate can pass up to $12.06 million free of federal estate tax.
The Clock Is Ticking
However, this "bonus" exclusion is not permanent and is scheduled to sunset on December 31, 2025, to pre TCJA levels unless Congress passes extending legislation.1 It is worth noting that while this sunset date is a current reality, it is possible that the exclusion could be reduced earlier. See our discussion on the tax changes proposed in Build Back Better Act.
What makes the federal "bonus" exclusion more interesting is that individuals in states with a state estate tax can make lifetime gifts to reduce potential state estate taxes.2 The reason this is possible is that many states that have a state estate or inheritance tax do not have a state gift tax. Therefore, residents of states without a state gift tax can utilize the increased federal gift exclusion amount to make lifetime gifts free of federal gift tax, thereby reducing the value of their gross estate that may be subject to state estate tax.
Larger Gifts Maximize Benefits
The Treasury Department has issued regulations stating that there will be no "clawback" of gifts made using the TCJA "bonus" exclusion if a donor's death occurs at a time when the exclusion is lower than when the gifts were made. While a significant benefit if you make full use of the $12.06 million exclusion, there is a potential drawback if lifetime gifting does not exceed the $5 million base exclusion. This is because when taxable gifts are made, the "bonus" exclusion does not get applied until the entire base exclusion amount has been used up.
For example, if you make $6.4 million of gifts prior to 2026 and then pass away in a year when the exclusion reverts to $6.4 million, your estate will have a remaining estate tax exclusion of $0. If you were to instead make $12.06 million of gifts prior to 2026 and then pass away in a year when the exclusion reverts to $6.4 million, your estate will still have a remaining estate tax exclusion of $0, but you will have removed $5.66 million more from your gross estate without any clawback of the excess exclusion used, and you have avoided estate tax on that $5.66 million of value.
What this calculation illustrates is that the use of the "bonus" exclusion is maximized the more you can give over the projected 2026 base amount of $6.4 million.
How to Structure the Gift
For those individuals able to make gifts of the entire "bonus" exclusion available prior to its sunset at the end of 2025, there is an opportunity for significant tax savings. Lifetime gifts can be simple or complex and can often involve charitable components or trusts. If you would like to discuss potential gifting strategies or your estate plan in general, please do not hesitate to contact the estate planning team at Davis Wright Tremaine.
1 Current inflation numbers suggest that the 2026 unified gift and estate exclusion will be approximately $6.4 million per person.
2 Currently 19 states have some form of an estate or inheritance tax in addition to the federal estate tax. Of relevance here are the District of Columbia ($4.254 million), Washington ($2.193 million exclusion), New York ($6.110 million exclusion), and Oregon ($1 million).