Estate taxation has been a long-standing political hot potato, as there is substantial debate about the societal costs and benefits of allowing families to pass wealth down over generations. Since 2017, what hasn’t been an area of concern for the vast majority of U.S. families is their own personal exposure to estate tax.
Signed into law on December 22, 2017, the legislation informally known as the Tax Cuts and Jobs Act (TCJA) doubled the basic exclusion amount (BEA) for 2018 from $5.59 million to $11.18 million. The BEA represents the total amount that an individual can transfer—free of gift or estate tax—to anyone they chooses. The BEA can be fully utilized during life by making gifts. Any balance that hasn’t been used via gifting is available to offset testamentary transfers contemplated by an individual’s will and/or living trust documents.
Indexed annually for inflation, the BEA is $12.06 million per person in 2022 and will increase to $12.92 million in 2023. At these levels, it is estimated that more than 95% of individuals would not be subject to tax.
The wrinkle that individuals should consider is that the BEA increase is temporary. To comply with government budgetary constraints surrounding the TCJA’s passage, a number of provisions of the law were constructed to sunset at the end of 2025. Thus, barring further congressional action, the BEA will revert back to its original progression and the 2026 BEA will be half of its 2025 level (but would receive the typical annual inflationary adjustment). Given the current contentiousness between the two major political parties, it seems unlikely that any agreement to extend the current BEA provisions might be reached. Thus, there is perhaps a good chance the BEA will decline by somewhere in the $6.5–7.5 million range in a little over three years.
The specter of sunset has left taxpayers with a short window of time to make the best use of the BEA increase. The operative issue is doing this in an effective and efficient manner. The timing of this transition is the reason for this article’s title. There is likely to be a large volume of individuals seeking to meet with their estate planning attorneys by the end of 2025. Savvy individuals should try to beat the crowd and begin their planning early.
For those looking to lock in the benefit of the potentially disappearing BEA, the goal is to transfer assets that cumulatively push them over the projected post-sunset BEA, i.e., approximately $6.5 million. While gifting is a worthwhile consideration for individuals who may not currently be at this level of wealth, that isn’t the focus of this article.
Many individuals with a net worth well in excess of $6.5 million may not be comfortable parting with that portion of their wealth. One option for individuals in this cohort to consider is a spousal lifetime access trust (SLAT). A SLAT is an irrevocable trust created for the benefit of their spouse and children and/or other descendants. Ideally, assets would be retained within the SLAT and not distributed to the spouse to gain full benefit of the transfer for estate tax purposes. However, the terms of the SLAT can allow for distributions to the spouse in certain circumstances.
The SLAT is not without potential downsides. The gifting spouse must consider the possibility of a future divorce. While the trust agreement can be written with terms that would remove a divorced spouse’s beneficial interest, the property cannot be revested directly to the gifting spouse. In such a situation, the gifting spouse might be left with little net worth of their own while the trust for the benefit of their children holds a large amount of assets.
There also is a timing risk. Spouses are free to set up SLATs for each other. However, if these two trusts are set up at the same time and have the same terms, the IRS could seek to apply the “reciprocal trust doctrine” to argue that no change in economic terms has actually occurred and that the gifted assets should continue to be included in the respective donor’s taxable estates.
You can learn more about SLATs with our FORsights™ article, “Do You Need a Spousal Lifetime Access Trust?” If you have any questions about the applicability of the BEA changes to your personal situation, please reach out to a professional with FORVIS Private Client™ or submit the Contact Us form below.
Read more articles from the FORVIS' 2022 tax guide.