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Are Families Who Took Advantage of the Temporary Increase in the Unified Credit for Estate and Gift Taxation Purposes in for a Very Unpleasant Surprise after 2025?

Are Families Who Took Advantage of the Temporary Increase in the Unified Credit for Estate and Gift Taxation Purposes in for a Very Unpleasant Surprise after 2025?

By Anthony Diosdi

Estate and Gift Tax 101

On December 31, 2012, President Obama signed the Economic Growth and Tax Relief Reconciliation Act exempting $5,120,000 (indexed for inflation) from estate and gift taxes, and the generation-skipping transfer taxes (“GST”). The Tax Cut and Jobs Act of 2017, the current law signed by President Trump on December 22, 2017, essentially doubled the transfer tax exemptions from $5 million to $10 million, indexed for inflation. The Tax Cuts and Jobs Act of 2017 currently excludes $11.4 million of assets from estate and gift taxes of a U.S. citizen or resident. However, many of the provisions of the Tax Cut and Jobs Act of 2017 are scheduled to expire on December 31, 2025. This means that on January 1, 2026, the estate and gift tax, and the GST exemption will revert back to $5.6 million.

The way the estate tax is computed on the gross estate of a decedent takes into consideration “the value at the time of his death all property, real or personal, tangible or intangible, wherever situated.” See IRC Section 2031. After the taxable estate has been determined by subtracting deductions from the gross estate, the tax is determined by subtracting deductions from the gross estate, the tax is determined by applying the rates and computation method of Internal Revenue Code Section 2001 to the base: the taxable estate. The estate tax is payable by the executor of the estate. Estate and gift (gift taxes will be discussed in more detail below) taxes the two parts of a “unified” transfer tax system. In the year 2020, the top estate and gift tax rate is 40 percent. The “unified credit” (sometimes known as the “estate tax credit” or “gift tax credit,” as the case may be) allows an individual to make certain amounts of taxable transfers free of the transfer tax. As discussed above, this amount is currently $11,400,000.

Gift tax is a companion to the estate tax. Contrary to common misconception, the transfer of an asset as a gift does not subject the donor or recipient to income tax liability. However, a donor (a person who makes a gift during his lifetime is called a “donor”) of property may recognize gift tax liability after the allowance of certain exclusions and deductions. Gift tax rates are cumulative based on how much the donor has given away. Like the estate tax, the current top rate is 40 percent.

The Internal Revenue Code permits an individual to disburse up to $15,000 worth of assets every year to as many people as he likes, gift-tax free without reporting the transfer. Under the annual exclusion, a U.S. person may exclude from “the total amount of gift” for a calendar year (the starting point of taxable gifts) up to $15,000 to an individual or as many individuals as she wishes. To illustrate, an individual could make $15,000 gifts to everyone in San Francisco during the current calendar year without incurring a gift tax. However, any gift that exceeds the annual exclusion is considered a taxable gift, and must be netted against a taxpayer’s lifetime exclusion (currently $11.4 million). If several gifts are made to the same donee in the same year, only $15,000 of exclusion is available, but applies to the total gifts to that donee which exceeds $15,000 should be reported to the IRS on Form 706 (the regular gift tax return form).

Whether an individual who transfers anything above this “annual exclusion” will owe any gift tax on the transfer depends on whether she has used up her lifetime exemption.

Is there a Clawback For Purposes of the Estate and Gift Tax For the Periods Between 2018 and 2015?

As discussed above, the current lifetime exemption for the estate and gift tax is $11.4 million. However, at the end of 2025, the current lifetime exemption is set to revert back to $5.6 million. What happens if an individual gifts $11.4 million and dies in 2025? Will the decedent’s estate be subject to estate and gift tax between the difference? The IRS has recently issued Treasury Regulation Section 20.2010-1(c) to address the temporary impact of the 2017 Tax Cuts and Jobs Act in computing the estate and gift tax. The IRS has confirmed that individuals who have taken advantage of the increased “unified credit” by gifting assets during the 2018 through 2025 calendar years will not be adversely impacted when the unified credit is set to decrease to pre-2018 levels. 

Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in tax matters domestically and internationally throughout the United States, Asia, Europe, Australia, Canada, and South America. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.