The following is a brief summary of the changes to the estate, gift, and GST exemptions that will occur due to the sunset of provisions in the Tax Cuts and Jobs Act of 2017. Our team outlines some of the timely implications on tax planning and estate planning that should be considered. For a broader overview of the tax law changes expected in 2026, read this blog post.
Introduction
The Tax Cut and Jobs Act (TCJA) of 2017 was a major tax reform that, amongst other changes, doubled the estate, gift, and generation-skipping transfer (GST) tax exemptions from $5 million to $10 million per person, indexed for inflation, for years 2018-2025.
As of January 2024, an individual can transfer up to $13.61 million and a married couple can transfer up to $27.22 million to their heirs or beneficiaries without paying any federal estate, gift, or GST tax.
However, the TCJA also included a sunset provision that will revert the exemptions back to their pre-2018 levels (adjusted for inflation) after December 31, 2025. Unless Congress acts to extend or make the TCJA provisions permanent, the exemptions will drop by 50% to about $7 million per person and $14 million per married couple in 2026. This will have a significant impact on the estate planning strategies of many taxpayers who may face higher taxes on their wealth transfers in the future.
What are the federal estate, gift, and GST taxes and exemptions?
Estate, gift, and GST taxes are the types of taxes imposed on the transfer of wealth. The estate tax is a tax on the transfer of wealth at death. The gift tax is a tax on the transfer of wealth during life. The GST tax is a tax on the transfer of wealth to a person who is two or more generations younger than the donor, such as a grandchild. The federal exemptions are the amount of wealth that can be transferred without paying these types of wealth transfer tax (federal estate, gift, and GST tax). The federal gift and estate exemptions are unified, meaning that they apply to the combined amount of lifetime gifts and transfers at death. The federal gift exemption is also portable, meaning that a surviving spouse can use the unused gift exemption of the deceased spouse.
The federal estate, gift, and GST exemptions are reduced by the value of taxable gifts made during life. For example, if Joan made $6 million of taxable gifts to her children in 2018 and $4 million of taxable gifts to her grandchildren in 2019, her remaining gift and estate exemption in 2024 would be $3.61 million ($13.61 million – $10 million of gifts) and her remaining GST exemption would be $9.61 million ($13.61 million – $4 million of gifts to grandchildren). Any amounts over the federal exemptions are subject to a flat tax rate of 40%. So, if Joan passed away in 2024, she would only have $3.61 million of federal estate exemption remaining to offset the transfer of wealth to her descendants from her taxable estate at her death. If Joan’s taxable estate exceeds $3.61 million at her death in 2024, there will be a federal estate tax due. However, all of the appreciation and growth on the assets that she gifted during her lifetime would be excluded from her taxable estate and would therefore not be subject to federal estate tax.
What are the implications of the TCJA sunset provision?
The sunset provision means that the exemptions will revert back to their pre-2018 levels (adjusted for inflation) after 2025 and will be cut in half. This could create huge tax consequences for many taxpayers who may have planned to use the higher exemptions to transfer their wealth to their heirs or beneficiaries but failed to do so.
If you can afford to make larger gifts, you can maximize the wealth transferred to your descendants, as the gifted assets and all the growth in those gifted assets is removed from your taxable estate and not subject to estate tax at your passing. The IRS has ruled that those who make lifetime gifts between 2018-2025 that exceed the lifetime gift, estate, and GST exemption in effect in the taxpayer’s year of death will not be penalized. However, this is a “use it or lose it” proposition. When the lifetime gift, estate, and GST exemptions drop by 50% in 2026 (from ~$14 million in 2025 to ~$7 million in 2026), if you have not made larger gifts (greater than ~$7 million+) before then, you will have lost the opportunity to gift the higher pre-2026 lifetime federal gift and GST exemption amounts and create wealth for your children and future generations. For example, you can currently gift up to $13.61 million ($27.22 million if you are married) to a long-term dynasty trust for the benefit of multiple generations that would never be subject to federal gift, estate, or GST tax, either at your passing or at any descendant’s passing.
What are some estate planning strategies to consider?
Given the uncertainty and the potential tax savings, taxpayers who have estates that exceed or are close to the current federal exemptions may want to consider some estate planning strategies to take advantage of the higher federal exemptions before they expire. Some of these strategies include:
- Making lifetime gifts to family members, trusts, or charities, either outright or in trust, to reduce the size of the taxable estate and lock in the higher exemptions.
- Using the annual gift and GST tax exclusion ($18,000 per recipient in 2024) to make tax-free gifts to descendants and other beneficiaries each year.
- Paying your descendants’ medical expenses or tuition directly to medical providers or educational institutions, as those are considered tax-free gifts.
- If married, creating and making gifts to a dynasty Spousal Lifetime Access Trust (SLAT) for the benefit of the spouse and descendants while retaining access to the trust assets through the beneficiary spouse if needed.
- Using a Grantor Retained Annuity Trust (GRAT) to transfer future appreciation of assets to children at a low or zero gift tax cost.
- If charitably inclined, using a Charitable Lead Annuity Trust (CLAT) to make a gift to a trust that pays an annuity to a charity for a term of years and then distributes the remaining assets to children at a low or zero gift tax cost.
- Using a Qualified Personal Residence Trust (QPRT) to transfer a residence to children at a reduced gift tax cost.
- Selling assets to a dynasty Intentionally Defective Grantor Trust (IDGT) to reduce the size of the taxable estate and transfer future appreciation of assets to children and more remote descendants at a zero gift tax cost.
I want to make gifts to trusts for my children and grandchildren, but the TCJA sunset doesn’t occur until 2026. Do I need to do anything right now in 2024?
The process of creating and funding trusts takes longer than many realize. First, the mechanics of making actual gifts takes time, especially if you want to make large lifetime gifts to long-term trusts for the benefit of beneficiaries such as children or grandchildren. You will need to meet with an experienced estate planning attorney to decide who the beneficiaries are, who the trustees and successor trustees will be, the circumstances under which distributions may be made, when you want the trust to ultimately terminate and how the trust assets are distributed at termination, and the best assets to gift to those trusts. The attorney would then need some time to draft the trust document. Depending on the attorney, it could take a couple of weeks to over a month just to get a trust drafted and executed.
After the trust is signed, funding the trust may take some time as well. Retitling certain illiquid investments such as real estate, business interests, carried interests, or private equity interests may require significant coordination and time. In addition, if you are gifting assets other than cash or marketable securities, a formal valuation from a qualified appraiser will likely be required to determine the value of the gifted assets. A qualified appraiser may need a few months to complete the valuation.
I am married and my spouse and I both want to use our respective federal exemptions to transfer a substantial portion of our wealth to dynasty trusts for our descendants, but we’re afraid to give too much and not leave enough for ourselves to live on. What can we do?
You can consider gifting to a Spousal Lifetime Access Trust, or SLAT. A SLAT is a trust that a person can set up for the benefit of their spouse and their descendants. One spouse could use his gift exemption to fund a SLAT for the benefit of the other, with the other spouse leaving assets in her own name for them both to live on. While you give up all your rights and control over the gifted assets, the SLAT will be available for your spouse to access as a beneficiary of the SLAT which can be used for your joint support if needed. Ideally, from a wealth transfer perspective, the SLAT would only make distributions to your beneficiary spouse for your joint personal expenses when you have both exhausted your personally owned assets. While it is possible for each spouse to set up a SLAT for the benefit of the other, you must be careful not to violate the reciprocal trust doctrine.
What is the reciprocal trust doctrine?
In United States v. Estate of Grace, 395 U.S. 316, 324 (1969), the Supreme Court held that where donors create reciprocal trusts which do not change the economic position of each donor with respect to the trust assets, the trusts will be includible in each donor’s gross estate at death.
Let’s say that John and Mary are married and have enough wealth to each create and fund SLATs for the benefit of the other. Their goal is to use each of their remaining gift and GST exemptions to gift to dynasty SLATs that will be excluded from their taxable estates but still allow access through the beneficiary spouse should they exhaust their own personal funds. John creates and transfers $13 million of assets to a SLAT for the benefit of Mary, allocating $13 million of his GST exemption to the gift. The next week, Mary creates and transfers $13 million of assets to a SLAT for the benefit of John, allocating $13 million of her GST exemption to the gift. In an audit, the IRS would apply the reciprocal trust doctrine and take the position that the two dynasty SLATs are includible in John and Mary’s taxable estates. Under the reciprocal trust doctrine, the IRS would assert that the trusts are virtually identical and leave each of John and Mary in the same economic position as if they each created trusts naming themselves as lifetime beneficiaries, thereby making the SLATs includible in their respective taxable estates.
How can we obtain the benefits of gifting to our SLATs without violating the reciprocal trust doctrine?
To reduce the risk of the reciprocal trust doctrine undoing your plan, it is best to wait for a long period of time between the creation and funding of the two SLATs. For example, if John creates and gifts assets to the SLAT for the benefit of Mary today, it is best if Mary waits until at least January of the following calendar year or even later to create and gift assets to the SLAT for the benefit of John. Other ways to lessen the risk of violating the reciprocal trust doctrine are making sure the two SLATs have different distribution provisions, different beneficiaries, different trustees, gifting a different portfolio of assets to each of the SLATs and giving one beneficiary spouse withdrawal rights or the power to change how the assets in one of the SLATs are divided during life or at that beneficiary spouse’s passing.
What is the step transaction doctrine?
The IRS can also apply the step transaction doctrine to treat a series of formally separate steps as a single transaction to undo the tax benefits of your estate plan.
In the example above, let’s say John and Mary have their assets in jointly held accounts or the assets are mostly in Mary’s name. To implement the plan, Mary first gifts $12 million of assets to John which qualify for the unlimited marital deduction. The next day, John then creates and funds the SLAT for Mary’s benefit with that same $12 million portfolio of assets he received from Mary. If the IRS ever audited the plan, the step transaction doctrine would likely apply, the initial gift from Mary to John would be ignored, and Mary would be treated as if she made the gift to the SLAT, rather than to John. This would be catastrophic, as under IRS rules, the entire SLAT would be treated as part of Mary’s taxable estate, negating the benefit of excluding the SLAT from both John and Mary’s taxable estates.
The step transaction doctrine may apply in other circumstances as well. For example, let’s assume that prior to funding the SLAT for Mary’s benefit, John decides to first transfer the $12 million portfolio of marketable securities to a family limited partnership (FLP) or LLC. A week later, John gifts the FLP interests (rather than the underlying marketable securities) to the SLAT and claims a discounted gift value which is less than the value of the underlying marketable securities due to lack of control or marketability of the FLP interests. The IRS could argue that the step transaction doctrine should apply and treat it as if John gifted the marketable securities (rather than the FLP interests) directly to the SLAT, negating the benefit of gifting discounted FLP interests.
How can we obtain the benefits of gifting to our SLATs without violating the step transaction doctrine?
Though there is no guaranteed way to avoid the application of the step transaction doctrine, there are some things John and Mary could do to lessen the risk. For example, John should hold the $12 million of assets received from Mary for as long as possible (ideally a different calendar year) and reinvest the $12 million of assets to his own preferences before creating and funding the SLAT for Mary’s benefit. John and Mary should analyze whether he can afford to gift to a SLAT and if so, how much he can afford to gift after discussing with a qualified financial planner. f John determines he can afford to gift a certain amount while still meeting their financial goals, he should analyze what assets to gift to the SLAT for Mary’s benefit. If an FLP or LLC is set up to hold and organize management of the underlying assets, and John determines he can afford to gift some of the FLP or LLC interests, he should consider waiting for a period (ideally a different calendar year) before gifting the FLP or LLC interests to the SLAT. For example, if you and your spouse have not used any of your federal lifetime gift and GST exemptions yet, and you both would like to use your respective lifetime gift and GST exemptions before the 2026 sunset, your timeline may look something like this:
- May 2024 – Meet with your financial advisor to review and analyze how much you can afford to gift while still meeting all your financial goals.
- May 2024 – Split assets between you and your spouse so you individually own enough assets to live on, and for each to be able to utilize federal lifetime gift and GST exemptions, and state estate exemptions (if applicable). Reinvest some of the split assets for a different mix of portfolio assets. Make sure the assets you plan on gifting to the trust have been in your own individual account for at least a few months before you gift to the first trust.
- June 2024 – Meet with your estate planning attorney to review and draft the first trust to which you plan to gift.
- July 2024 – Review the draft of the trust and finalize execution of the first trust.
- October 2024 – You gift $13.61 million of assets to a SLAT for the benefit of your spouse and allocate $13.61 million of GST exemption to the gift.
- January 2025 – Meet again with your financial advisor to analyze and confirm whether you and your spouse will have sufficient assets to live on if your spouse gifts assets to a SLAT for your benefit and determine how much your spouse can afford to gift to allow your children to access those assets as SLAT beneficiaries during your lifetime.
- February 2025– Your spouse meets with the estate planning attorney to review and draft the SLAT for the benefit of you and your descendants, to which your spouse plans to gift.
- March 2025 – Your spouse reviews the draft of that SLAT and finalizes execution of that SLAT.
- April 2025 – Your spouse gifts assets to that SLAT and can gift up to the available gift and GST exemption in effect in 2025 (expected to be ~$14M+).
Conclusion
The TCJA provides a temporary opportunity for taxpayers to transfer more wealth to their descendants without paying any federal estate, gift, or GST tax. However, this opportunity will expire after 2025 unless Congress acts to extend or make permanent the TCJA provisions. The goal of any good estate plan is to transfer wealth to your intended beneficiaries in the most efficient way possible. It is best practice to analyze the impact of your estate plan to your financial planning goals and implement your overall wealth transfer plan over time (over different calendar years if possible) to reduce the risk of the IRS negating the benefits of the plan. If your level of wealth exceeds or is close to the current federal exemptions, you should consult with your wealth, investment, tax, and estate planning advisors as soon as possible to explore and implement strategies to use the higher federal exemptions before the TCJA 2026 sunset.
