It is no secret that the federal estate tax exemption was increased under the TCJA in 2017 to over $11 million per taxpayer. There has been much discussion recently about the growing wealth inequality in the US and questions of whether the current gift & estate tax structure perpetuate this inequality. To this end, virtually all of the Democratic presidential candidates for 2020 have included provisions in their tax plans to reduce the estate tax exemption, potentially to a figure that is even lower than the pre-2018 level.
The increased estate tax exemption is already scheduled to return to its pre-2018 level, approximately half of what it is currently, beginning in 2025. With the uncertain political climate raging on until the 2020 election season, there is the potential for a decrease to the exemption amount to materialize much earlier than its originally scheduled 2025 roll back.
What happens to gifts made under the current rules if the exemption amount were to decrease in a future year? The IRS has clarified that for taxpayers in confirming that there will be no claw back of gifts made under the current higher exemption when the exemption drops back down (in 2025 or earlier). Let’s look at an example of how this rule helps taxpayers.
John owns 100% of ABC Corp, a manufacturing company that he founded nearly two decades ago. He works with a valuation expert to determine that his shares are worth $6 million as of June 30, 2019. John, who has never gifted before, knows that the estate tax exemption is high and decides that now is the right time for a gift to his son, Jim. John decides to gift all of his ownership to Jim. As the exemption for 2019 is $11 million, John is below the exemption amount and has no gift tax due.
Let’s say that John passes away in 2026, when the estate tax exemption is around $5 million and there was no appreciation in the value of his stock in ABC Corp. Here is where the no claw back rule comes into play. Even though the exemption amount is $5 million at the time of John’s death, and John has made lifetime gifts of $6 million, he has no estate tax due, as the $6 million gift was made in a year when the exemption was higher.
If he had not gifted his ownership to Jim in 2019, John would have died with stock valued at $6 million, resulting in estate tax owed on the $1 million of value in excess of the estate tax exemption. So, by John making a gift in a high estate tax exemption year, he saved on estate taxes. He chose to “use it” in 2019 by making a gift, so he did not “lose it” upon his death in a year where the exemption was much lower.
So, with the estate tax exemption amount as high as it may ever be, is now the right time to make gifts of assets, potentially gifting ownership in a privately held business that may appreciate in value? It may make sense to take a look. This estate planning issue makes it clear that knowing the value of your stock in a closely held business is imperative. It is often beneficial to have an independent, third-party valuation expert in your corner to help you along the way as part of your team of trust advisors.