By Barry Zimmer on December 15th, 2020 in Estate Planning
Inheritances are not subject to regular income taxes, but there is a federal estate tax that can enter the picture. Fortunately, most families do not have to worry about it, because there is a credit or exclusion that you can use to transfer a certain amount tax-free.
We are going to share an update that has recently been released by the Internal Revenue Service with regard to next year’s exclusion, but we will provide some historical context first.
Exclusion Changes Over Recent Years
It is interesting to see the profound estate tax exclusion changes that have been implemented over the last 20 years. In 2001, it stood at $675,000, and the maximum rate was 55 percent.
It went up to $1 million with a 50 percent rate in 2002, and it gradually made its way up to $3.5 million with a 45 percent rate in 2009. Under the terms of the Bush tax cuts, the estate tax exclusion was repealed for the 2010 calendar year.
The tax legislation that President Bush signed into law was scheduled to expire or sunset at the end of 2010. If no new tax bill was passed, the exclusion would go back to the $1 million that was in place in 2002 with the 50 percent maximum rate.
This never materialize because the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (H.R. 4853) was enacted at the end of that year. It established a $5 million exclusion and a 35 percent top rate.
The American Taxpayer Relief Act of 2012 kept the $5 million exclusion adjusted for inflation, and it increased the rate to 40 percent. An increase in the rate is not exactly an act of taxpayer relief, but other portions of the bill did include tax breaks for some segments of the population.
These were the parameters until the Tax Cuts and Jobs Act was enacted in December of 2017. This piece of legislation increased the exclusion to $11.18 million, and the 40 percent rate was retained.
There have been inflation adjustments since then, and the Internal Revenue Service has announced that the exclusion in 2021 will be $11.7 million.
We should point out the fact that this is another legislative measure that will sunset, and the expiration date is January 1, 2026. If nothing changes in the meantime, the exclusion will go back down to the $5.49 million that we had in 2017 adjusted for inflation.
Federal Gift Tax
The logical reaction to the estate tax would be lifetime gift giving, and people used to give gifts to avoid the estate tax after it was enacted in 1916. A gift tax was established in 1924 to put the kabosh on this approach, but it was repealed in 1926.
It was reenacted in 1932, and it has been in place continually since then. The gift tax and the estate tax are unified under the tax code, so the $11.7 million exclusion that we will have next year as a unified exclusion that applies to lifetime gifts and estate transfers.
In addition to this unified lifetime exclusion, there is a $15,000 annual exclusion. You can give this much to any number of people within a calendar year free of taxation. There is no limit to the total amount you can give tax-free as long as you do not give more than $15,000 to any one person.
If you want to pay medical bills for others, you can do this without incurring any gift tax liability, and the medical exemption extends to the payment of health insurance premiums. There is also an educational exemption that you can use to pay school tuition for others tax-free.
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FAQs
It is scheduled to expire, or “sunset,” on December 31, 2025, unless Congress acts to extend it or make it permanent. If no action is taken, the exemption amount will revert to its pre-TCJA level of $5.6 million per individual, adjusted for inflation from 2017.
What happens to DSUe after 2025? ›
In short, the scheduled sunset of the applicable exclusion amount does not apply to the larger, albeit still unused, DSUE. Conclusion: When a spouse dies before 2026 and that deceased spouse's unused DSUE is ported to the surviving spouse, any unused portion of the top half of SDUE will not expire after 2025.
What happens to the federal estate tax exemption in 2026? ›
There's also this to consider: The record-high estate tax exclusion amount now allowed is scheduled to be cut roughly in half on January 1, 2026. Currently, you can transfer up to $13.61 million free of estate taxes during your lifetime. Married couples can gift $27.22 million.
What is the federal estate tax exemption for 2024? ›
Effective January 1, 2024, the federal estate and gift tax exemption amount increased from $12.92 million to $13.61 million per individual (a combined $27.22 million for a married couple), representing an increase of $690,000.
What is the sunset clause in 2025? ›
TCJA Changes to Individual Income Taxes
Key provisions of the TCJA that are going to sunset in 2025 include: Lower marginal tax brackets. Increased standard deduction. State and local taxes $10,000 capped deduction limit.
Will making large gifts now won't harm estates after 2025? ›
Final regulations confirm: Making large gifts now won't harm estates after 2025.
How to avoid federal estate tax? ›
Certain types of trusts can help avoid estate taxes. An irrevocable trust transfers asset ownership from the original owner to the trust beneficiaries. Because those assets don't legally belong to the person who set up the trust, they aren't subject to estate or inheritance taxes when that person passes away.
Will portability go away in 2026? ›
Within a marriage, each spouse has a unified exclusion amount of $12,920,000. The Tax Cut and Jobs Act of 2017 (TCJA, P.L. 115-97) temporarily doubled the applicable exclusion amount for tax years 2018–2025. Without amendment, the exclusion will revert to half of the inflation-adjusted amount in 2026.
What is the DSUE ordering rule? ›
The regulations include an ordering rule, providing that if a surviving spouse makes a gift with a DSUE amount from the last deceased spouse determined at the time of the gift, “such surviving spouse will be considered to apply such DSUE amount to the taxable gift before the surviving spouse's own basic exclusion ...
What tax laws will sunset in 2025? ›
Most of the tax changes in the 2017 Tax Cuts & Jobs Act (TCJA) expire (sunset) at the end of 2025. TCJA featured tax cuts and some tax hikes to help pay for it. Meanwhile, TCJA's massive tax cut lowering the corporate tax rate to 21% does not expire.
At the end of 2025, the individual tax. provisions in the Tax Cuts and Jobs Act (TCJA) expire all at once. Without congressional action, most taxpayers will see a notable tax increase relative to current policy in 2026. In 2026, business taxes will also be higher as 100 percent bonus depreciation.
Why is 2026 an important year? ›
Federal estate tax in 2026
An end to the individual tax pro-visions in the TCJA would also increase the number of taxpayers who are subject to the federal estate tax. In 2024, up to $13.61 million in assets is exempt from estate tax, or up to $27.22 million for a married couple.
What happens to the federal estate tax in 2025? ›
The increased estate and gift tax exemption, which is currently $12.92 million per person and increased to $13.61 million per person for 2024, is set to sunset at the end of 2025. As a result, the exemption will drop back to the prior Tax Cuts and Jobs Act (TCJA) level of $5 million, adjusted for inflation.
How does IRS know you gifted money? ›
The primary way the IRS becomes aware of gifts is when you report them on form 709. You are required to report gifts to an individual over $17,000 on this form. This is how the IRS will generally become aware of a gift. However, form 709 is not the only way the IRS will know about a gift.
How much can you inherit without paying federal taxes? ›
This threshold gradually rises every year to account for inflation over time. As of 2023, your estate is required to pay the federal estate tax if the value of your taxable estate exceeds $12.92 million and increases to $13,610,000 for 2024.
What is the trust tax rate for 2025? ›
Ordinary income tax rates for trusts and estates for taxable years beginning after December 31, 2018, and continuing through December 31, 2025, range from 10% to 37%. If an estate or trust generates more than $600 in annual gross income, a Form 1041 (Income Tax Return for Estates and Trusts) must be filed.
What is the future of the federal estate tax? ›
The increased estate and gift tax exemption, which is currently $12.92 million per person and increased to $13.61 million per person for 2024, is set to sunset at the end of 2025. As a result, the exemption will drop back to the prior Tax Cuts and Jobs Act (TCJA) level of $5 million, adjusted for inflation.
Does the TCJA expire in 2025? ›
Several provisions from the Tax Cuts and Jobs Act of 2017 are scheduled to expire at the end of 2025 without changes from Congress. Enacted by former President Donald Trump, the law included lower tax brackets, a higher standard deduction and a boost to the child tax credit, among other changes.
