Overview
During 2022, COVID-19, the war in Ukraine, global inflation, the Tax Cuts and Jobs Act (TCJA), the uncertainty about the Build Back Better Act (BBBA), the Corporate Transparency Act (CTA), and the Inflation Reduction Act (IRA) dominated the planning landscape.
In our 2021 Year-End Estate Planning Advisory, there was a lot of uncertainty about whether the BBBA would be enacted and, if so, whether it would bring about a change in the estate, gift and generation-skipping transfer (GST) tax exemptions. At the end of the day, while a form of the BBBA passed the House (which form did not include a change to the aforementioned exemption amounts), the BBBA ended up being dead on arrival in the Senate.
As outlined in our previous Year-End Estate Planning Advisories, the TCJA made significant changes to individual and corporate income taxes, restructured international tax rules, provided a deduction for pass-through income and eliminated many itemized deductions. Most significantly for estate planning purposes, the TCJA temporarily doubled the estate, gift and generation-skipping transfer (GST) tax exemptions. Absent legislative action by Congress, many of the changes imposed under the TCJA ' including the increased exemptions ' will sunset after December 31, 2025, with the laws currently scheduled to revert back to those that existed prior to the TCJA. Given the uncertain political landscape, practitioners continue to view this temporary increase in exemption amounts as an unprecedented opportunity for valuable estate planning.
While the permanency of the TCJA's provisions still remains uncertain, the current environment provides a great deal of opportunity for new planning. We are encouraging clients to build flexibility into their estate plans and to use this window of opportunity, where appropriate, to engage in planning to take advantage of the increased estate, gift and GST tax exemptions.
As the existing tax landscape is still in effect as of the date of this advisory, and looks unlikely to change before the end of the year, particularly in light of the results of the midterm elections, the following are some key income and transfer tax exemption and rate changes under the TCJA, including inflation adjusted amounts for 2022 and 2023:
Federal Estate, GST and Gift Tax Rates
For 2022, the federal estate, gift and GST applicable exclusion amounts are $12.06 million. The maximum rate for federal estate, gift and GST taxes is 40 percent. For 2023, the federal estate, gift and GST applicable exclusion amounts will be $12.92 million. Absent any change by Congress, the maximum rate for federal estate, gift and GST taxes will remain at 40 percent.
Annual Gift Tax Exemption
Each year individuals are entitled to make gifts using the "Annual Exclusion Amount" without incurring gift tax or using any of their lifetime applicable exclusion amount against estate and gift tax. The Annual Exclusion Amount is $16,000 per donee in 2022. Thus, this year a married couple together can gift $32,000 to each donee without gift tax consequences. In 2023, the annual exclusion for gifts will increase to $17,000. The limitation on tax-free annual gifts made to noncitizen spouses will increase from $164,000 in 2022 to $175,000 in 2023.
Federal Income Tax Rates
- The TCJA provides for seven (7) individual income tax brackets with a maximum rate of 37 percent. The 37 percent tax rate will affect single taxpayers whose income exceeds $518,400 (indexed for inflation, and $578,125 in 2023) and married taxpayers filing jointly whose income exceeds $622,050 (indexed for inflation and $693,750 in 2023). Estates and trusts will reach the maximum rate with taxable income of more than $12,950 (indexed for inflation and $14,450 in 2023).
- A zero percent capital gains rate applies for single taxpayers with income up to $40,000 (indexed for inflation, and $44,625 for 2023) or married taxpayers filing jointly with income up to $80,000 (indexed for inflation, and $89,250 in 2023). A 15 percent capital gains rate applies for income above this threshold up to $441,450 for single taxpayers (indexed for inflation, and $492,300 in 2023) and $496,600 for married taxpayers filing jointly (indexed for inflation, and $553,850 in 2023). The 20 percent capital gains rate applies above these thresholds.
- The standard deduction was increased to $12,000 for single taxpayers (indexed for inflation, and $13,850 for 2023) and $24,000 for married taxpayers filing jointly (indexed for inflation, and $27,700 in 2023).
- The threshold for the imposition of the 3.8 percent Medicare surtax on investment income and 0.9 percent Medicare surtax on earned income is $200,000 for single taxpayers, $250,000 for married taxpayers filing jointly and $12,500 for trusts and estates (adjusted for inflation).
Tax Cuts and Jobs Act
The TCJA, which was signed into law on December 22, 2017, and most of which became effective on January 1, 2018, has proven to have many implications for domestic corporate and individual income tax, as well as federal gift, estate and GST tax, fiduciary income tax and international tax. Since the TCJA's enactment, various technical corrections have been issued, as has the Internal Revenue Service's (IRS) guidance on certain aspects of the new tax regime. In light of the TCJA and recent IRS guidance, it is important to review existing estate plans, consider future planning to take advantage of the increased exemption amounts, and maintain flexibility to allow for future strategic planning. Because of the continued importance of the TCJA's new tax laws, the most significant changes and recent guidance are summarized below.
Gift, Estate and GST Exemptions, Rates and Stepped-Up Basis
The TCJA retained the federal estate, gift and GST tax rates at a top rate of 40 percent, as well as the marked-to-market income tax basis for assets includible in a decedent's taxable estate at death.
While the federal gift, estate and GST taxes were not repealed by the TCJA, fewer taxpayers will be subject to these transfer taxes due to the TCJA's increase of the related exemption amounts. Under the TCJA, the base federal gift, estate and GST tax exemptions doubled from $5 million per person to $10 million per person, indexed for inflation. As noted above, the relevant exemption amount for 2022 is $12.06 million per person, resulting in a married couple's ability to pass $24.12 million worth of assets free of federal estate, gift and GST taxes. These amounts will increase each year until the end of 2025, with inflation adjustments to be determined by the chained Consumer Price Index (CPI) (which will lead to smaller increases in the relevant exemption amounts in future years than would have resulted from the previously used traditional CPI). The exemption amount in 2023 will be $12.92 million per individual, or $25.84 million per married couple. Without further legislative action, the increased exemption amounts will sunset, and the prior exemption amounts (indexed for inflation, using the chained CPI figure) will be restored beginning in 2026.
While the federal estate tax exemption amount has increased, note that multiple US states impose a state-level estate or inheritance tax. The estate tax exemption amount in some of these states matches, or will match, the increased federal estate tax exemption amount. However, in other states, such as Illinois and New York, the state estate tax exemption amount will not increase with the federal estate tax exemption amount, absent a change in relevant state law. Additionally, states may have their own laws that impact planning in that state.
The federal estate tax exemption that applies to non-resident aliens was not increased under the TCJA. Under current law, the exemption for non-resident aliens remains at $60,000 (absent the application of an estate tax treaty).
'Anti-Clawback' Regulations
While there is uncertainty about whether future legislation will address the sunset, either by extending the new exemption amounts beyond 2025 or changing the exemption amounts further, the IRS has issued guidance on how it will address differences between the exemption amounts at the date of a gift and exemption amounts at the date of a taxpayer's death (often referred to as a "clawback"). In Proposed Regulations REG-106706-18, the IRS clarified that a taxpayer who takes advantage of the current lifetime gift tax exemption will not be penalized, if the exemption amount is lower at the taxpayer's death. If a taxpayer dies on or after January 1, 2026, having used more than the statutory $5 million basic exclusion (indexed for inflation) but less than the $10 million basic exclusion (indexed for inflation), the taxpayer will be allowed a basic exclusion equal to the amount of the basic exclusion the taxpayer had used. However, any exemption unused during a period of higher basic exclusion amounts will not be allowed as an additional basic exclusion upon death. Additionally, the IRS clarified that if a taxpayer exhausted his or her basic exclusion amount with pre-2018 gifts and paid gift tax, then made additional gifts or died during a period of high basic exclusion amounts, the higher exclusion will not be reduced by a prior gift on which gift tax was paid.
The Proposed Regulations do not permit gifts made during the period that the basic exclusion amount is $10 million (indexed for inflation) to "come off the top" of the higher basic exclusion amount. For example, if a taxpayer who has never made a taxable gift makes a gift of $5 million, and then dies after the basic exclusion amount has decreased back to $5 million, the gift will not be deemed to use the "extra" (indexed) $5 million of basic exclusion amount available until 2026. Instead, the gift would be deemed to use the taxpayer's $5 million basic exclusion amount. The IRS could have provided that any gifts prior to 2026 come "off the top" of the $10 million exclusion amount. In that case, a...
