Despite the various proposals to lower federal transfer tax (estate, gift and GST taxes) exemptions and increase the tax rates, none of them were enacted in 2021. This means that the exemptions have increased for inflation in 2022, giving clients a “second bite at the apple” on locking in the advantageous rates and exemptions before they revert to $5 million in 2025, at the latest.
Tax Exemption Inflation Increases for 2022
For 2022 the increased transfer tax exemptions are as follows:
- $12,060,000 federal estate tax exemption and a 40% top federal estate tax rate.
- $12,060,000 GST tax exemption and a 40% top federal GST tax rate.
- Lifetime gift tax exemption is $12,060,000 and a 40% top federal gift tax rate.
- The annual gift tax exclusion amount increases to $16,000.
Although this increased exemption ends on December 31, 2025, the IRS and Treasury has clarified that the government will not “claw back” gifts given between 2018 and 2025, with respect to someone who dies in 2026 or beyond, that exceed $5 million, when the gift and estate tax exemptions return to the $5 million exemption under the 2012 Act.
The opportunity these increased exemptions under the 2017 Act create is to leverage larger lifetime gifts through a variety of estate planning techniques to shift income producing assets to individuals who may be in lower income tax brackets and/or reside in states with a lower income tax rate or no state income tax.
In particular, those who used substantially all of their prior exemptions should consider making additional lifetime gifts to utilize the increased exemptions in 2022. So, if you have used all of your $11.7 million exemption in 2021, you can gift an additional $360,000 tax free in 2022.
How Do These Changes Affect your Existing Estate Planning Documents?
Most estate planning documents are drafted to be flexible so their overall structure is unaffected by the increased exemption amounts. There are, however, always specific areas where you will want to update your documents.
One area is that, unlike the estate tax exemption, the GST tax exemption is not portable on a spouse’s death. States that have separate state estate tax regimes (such as Connecticut, Massachusetts and New York) do not permit estate tax exemption portability. Use of a Bypass Trust at the first death of a married couple may be most useful where these limits on portability are applicable.
Additionally, if you are a married couple and live in, or own real property in, a state with a state estate tax, such as Connecticut, Massachusetts or New York, there may be provisions that should be added to your documents which could save state estate taxes at the death of the first spouse.
Gift Tax Update
The gift tax annual exclusion amount per donee has increased to $16,000 for gifts made by an individual, and $32,000 for gifts made by a married couple who agree to \split\ their gifts, in 2022. In lieu of cash gifts, consider gifting securities or interests in privately held companies or other family-owned entities. The assets that you give away now, may be worth significantly less than they once were due to the effects of the Pandemic. The value of these assets, hopefully, will increase in the future, so creating a built-in discount that the Internal Revenue Service cannot reasonably question. That discount will inure to the benefit of your beneficiaries, if the value of those assets rises.
Your annual exclusion gifts may be made directly to your beneficiaries or to trusts that you establish for their benefit. It is important to note, however, that gifts to trusts will not qualify for the gift tax annual exclusion unless the beneficiaries have certain limited rights to the gifted assets (commonly known as \Crummey\ withdrawal powers). If you have created a trust that contains beneficiary withdrawal powers, it is essential that your Trustees send Crummey letters to the beneficiaries whenever you (or anyone else) make a trust contribution.
If you have created an insurance trust, remember that any amounts contributed to the trust to pay insurance premiums are considered additions to the trust. As a result, the Trustees should send Crummey letters to the beneficiaries to notify them of their withdrawal rights over these contributions. Without these letters, transfers to the trust will not qualify for the gift tax annual exclusion.
2021 Gift Tax Returns
Gift tax returns for gifts that you made in 2021 are due on April 15, 2022. You can extend the due date to October 15, 2022 on a timely filed request for an automatic extension of time to file your 2021 income tax return, which also extends the time to file your gift tax return. If you created a trust in 2021, you should direct your accountant to elect to have your GST tax exemption either allocated or not allocated, as the case may be, to contributions to that trust. It is critical that you not overlook that step, which must be taken even if your gifts do not exceed the annual gift tax exclusion and would, therefore, not otherwise require the filing of a gift tax return. You should call your attorney if you have any questions about your GST tax exemption allocation.
So, while the higher exemptions last, you will see an annual increase in the amount of the exemption, an increase that may significantly increase in rate, if the rate of inflation remains high. These higher exemptions will go away no later than the end of 2025.