The Sunset of the Doubled Estate, Gift, and GST Tax Exclusion Amounts After December 31, 2025

The TCJA doubled the lifetime exclusion and GST tax exemption. This exclusion amount, adjusted for inflation, is now $13.61 million and is expected to be approximately $13.99 million in 2025. However, in 2026, the amount will reduce to approximately $7.2 million unless Congress adopts a new law to prevent that from happening. This is a “use-it-or-lose-it” scenario for gift and estate tax planning with available exclusion.

The US Department of Treasury (Treasury) confirmed in 2019 that an individual who uses the increased exclusion at this time generally will not be taxed in a later year when the exclusion is subsequently reduced. As a result, using “excess” exclusion (over $7 million) for gifts before this opportunity expires in 2026 will generally accomplish a tax-free transfer of those gifted assets (and the future appreciation of those assets). One caveat under proposed regulations issued in 2022 (not yet finalized by Treasury) is that property which is given now but still taxable at death (such as in the case of certain interests in family-owned entities that are subject to the so-called “string provisions” of sections 2036 and 2038 of the Internal Revenue Code [IRC]) will be subject to the exclusion available at death, not the higher exclusion amount that was available when the gift was made. In addition, under these same 2022 proposed regulations, anti-abuse rules can apply where the taxpayer has made certain “phantom or deemed gifts” in an attempt to consume exemption by violating technical tax rules such as in cases of certain transfers that purposely trip the technicalities of IRC sections 2701 (in the case of certain preferred equity interests in entities that do not provide for “qualified payment rights”) or 2702 (such as in the case of grantor retained income trusts that do not include a qualified annuity interest and therefore fail to constitute a valid grantor retained annuity trust [GRAT]).

Example

If a taxpayer made a gift of $5.2 million today when the exemption amount is $13.61 million, and the exemption amount is reduced to $7.2 million in 2026, the taxpayer would have $2 million of exclusion remaining after the sunset. The client cannot use the “excess” exclusion and is effectively capped at $7.2 million (unless or until Congress changes the exclusion in the future).

However, if the taxpayer made a gift of $13.61 million today using all of the increased exclusion amount, then the client has effectively used the entire “excess” exclusion. There would generally be no “clawback” of the exemption previously used if the taxpayer died after 2026 when the exemption amount is reduced to $7.2 million in this example.

Planning Considerations

• Use Whatever You Can. For 2024 and 2025, the focus for high-net-worth clients will be on maximizing use of the higher exclusion and GST exemption. For many clients, full use of the exclusion is out of reach. But for married clients, it may be possible to partially use much or all of one spouse’s exclusion. This approach would allow the couple to use one and a half of their combined exclusion because they will only lose one spouse’s “excess” exclusion after the sunset. After the transfer in trust is accomplished, further planning can be considered, such as purchasing life insurance or selling assets to the trust. The first step is making the transfer, and it is usually acceptable for the details of additional planning opportunities to be developed in a second phase. The client usually does not need to make all of the decisions at once.
• If Unsure, Use SLATs. For clients with less assets available for gifting, a spousal lifetime access trust (SLAT) can provide a safety net during one or both spouses’ lifetimes. In a SLAT, one spouse is a beneficiary of the other spouse’s gift, but the expectation is that the beneficiary spouse will not need to take distributions. Therefore, the trust will appreciate over the couple’s lifetimes for the full transfer tax benefit.
• Terminate Non-Exempt Trusts. For a client who is close to death, consider terminating any non-exempt trusts for the client’s benefit to the extent the value is less than the available exclusion. This way, the assets will benefit from a basis step-up at death in the client’s estate. The terms of a non-exempt trust may create a general power of appointment for the client, which would make the assets taxable in the client’s estate. In this case, the exclusion available at the client’s death would be applied to the assets whether the trust is terminated or not. But if such a trust is subject to GST tax and not to estate tax (which may have been the result of planning that occurred when the exclusion was lower), terminating the trust or adding a general power of appointment would eliminate GST tax and would allow for the use of the client’s excess estate tax exclusion. The analysis for a particular client should take into account any state estate tax that is caused by forcing the assets into the taxable estate, which should be weighed against the benefits of the basis step-up. State estate tax exclusions are generally lower than the federal estate tax exclusion.
• Swap Assets With Grantor Trusts. For a client who is close to death, consider swapping assets with the client’s existing grantor trusts to push low-basis assets into the client’s estate and obtain a basis step-up at death for such assets that are swapped back into the client’s estate prior to death.
• Allocate GST Exemption to Existing Trusts. If a client has made a non-exempt gift in trust or created a GRAT that terminated into remainder trusts, consider allocating excess GST exemption to those trusts. A portion of a non-exempt trust equal to the client’s available GST exemption can be severed into a separate trust, and the client can allocate GST exemption to the severed trust. This approach allows the client to use the excess GST exemption without making an additional transfer, either because the client does not have appropriate assets for gifting or because the next generation already has “enough.”

Possible Legislative Updates

Given that this is an election year, it is exceedingly unlikely that any changes will be made to the TCJA provisions relating to exclusions in 2024. However, depending on the outcome of the election and the composition of both Houses of Congress, there may be action on this before December 31, 2025. In this regard, Vice President Kamala Harris’s presidential campaign has announced its endorsement of the estate tax reforms that are proposed in the American Housing and Economic Mobility Act of 2024, S. 4824, which was introduced in the Senate on July 29 by Senator Elizabeth Warren, among others. This bill includes the following estate tax-related reforms:

• Raising the estate and gift tax rates to 55% on taxable transfers of up to $13 million, 60% on taxable transfers between $13 million and $93 million, and 65% on taxable transfers over $93 million, and raising the GST tax rate to 65%.
• Lowering the basic exclusion amount to $3.5 million.
• Imposing a 10% surtax on taxable estates over $1 billion.
• Requiring that GRATs have a term of not less than 10 years, annuity payments that do not decrease during the first 10 years of the term, and a remainder interest equal in value to at least 10% of the value of the assets transferred to the trust, determined as of the time of the transfer.
• Substantial restrictions would be imposed upon the use of grantor trusts in estate planning.
• Substantial limitations would be imposed on the gift tax annual exclusion.
• Substantial restrictions would be imposed on the availability of valuation discounts for nonbusiness assets.

One question to consider is whether the House of Representatives could use the Budget Reconciliation process to expedite changes to the TCJA, even if neither party controls both Houses. Budget Reconciliation permits certain legislation related to revenue and spending to pass with fewer administrative hurdles. In theory, since the estate tax exclusion has a direct impact on revenue, it could be considered within the purview of the Budget Reconciliation process. Indeed, there is very recent precedent for this, as the Budget Reconciliation process was invoked as the basis to enact the TCJA in the first place, and the reason for the sunset after December 31, 2025, was to allow the total budgetary adjustments to come within the available budgetary cap for budget scoring purposes.

The Private Clients, Trusts and Estates practice at ArentFox Schiff will be monitoring for any updates in this area. In the meantime, clients who take advantage of the current exclusion will have accomplished valuable estate planning that generally reduces overall transfer taxes. Even if the exclusion levels are adjusted upward in the future, the appreciation of the gift property after the date of the gift will effectively be excluded from the client’s taxable estate. In this way, for clients who have assets to give at this level, it’s a win-win proposition.