Federal Gift and Estate Tax Planning- Part 2 of 7: Leveraging the Basic and Annual Exclusions

Maximizing Your Basic Exclusion

The primary reason the vast majority of North Carolinians avoid estate tax is by simply using their basic gift and estate tax exclusion which is historically high. The 2024 amount is $13,610,000 per individual and $27,220,000 for a married couple who elects portability.  Although some individuals may accomplish this without any planning, if an individual has a large estate, even if it is currently below the basic exclusion, there is simple planning which can leverage their basic exclusion. This leverage is due to the future growth of the gifted assets becoming removed from an individual’s taxable estate upon the gift. In other words, the value of the gift is calculated at the time that it is made and not the value at the time of death. 

Consider the Following Example:

An unmarried man makes a gift of $10,000,000 to his only child in 2018 (this was his only lifetime gift).  No gift tax is due at the time because during 2018 the basic exclusion was $11,180,000. 

The same man dies in 2023 with $15,000,000 remaining in his estate.  In 2023, the basic exclusion was $12,920,000. 

The only child has invested the $10,000,000 gift received in 2018 and generated an annual return of 5%, increasing the value of the gift to $12,762,815.

Assuming the man kept the $10,000,000 in 2018 instead of gifting it to his child, and generated the same annual return, his estate would be subject to roughly $1,105,126 in additional taxes. 

Estate tax due (making the gift in 2018): $4,832,000 (Total estate plus prior gift value ($25,000,000) less basic exclusion ($12,920,000) x 40%)

Estate tax due (making no gift): $5,937,126 (Total estate ($27,762,815) less basic exclusion ($12,920,000) x 40%)

Tax savings by making 2018 gift: $1,105,126

Anti-Clawback Regulation Bonus

Thanks to the IRS 2019 anti-clawback regulation, the basic exclusion can be especially maximized over the next two years due to the potential reduction of the exclusion on January 1, 2026.  With the exclusion amount scheduled to sunset on January 1, 2026, there was a question as to what would occur if an individual made a gift under the current basic exclusion amount but died at a time when the prior gift exceeded the basic exclusion amount.  Would the entire amount of the prior gift be clawed back or just the amount equal to the basic exclusion at death? Fortunately, the IRS has advised the latter. Therefore, if you have an estate that will likely be taxable either under the current exclusion amount or the reduced amount in 2026, gifting now is the smart strategy as it is essentially “use it or lose it” with respect to the higher exclusion amount and the anti-clawback regulation clarifies that there will be no unexpected penalty for using the higher basic exclusion amount if the sunset does indeed occur as anticipated.     

Consider the Following Example:

An unmarried man makes a gift of $11.18 million to his only child in 2018 (this was his only lifetime gift).  No gift tax is due at the time because during 2018 the basic exclusion was $11.18 million. 

The same man dies in 2026 with $15 million remaining in his estate.  In 2026, the basic exclusion has reverted to the pre-2017 amount of $5.6 million and indexed for inflation is $7 million. 

Without the anti-clawback regulation, estate tax could be assessed at 7.67 million ($26.18 million ($15 million plus prior gift of $11.18 million) less the $7 million basic exclusion x 40%)

With the anti-clawback regulation, estate tax assessed would instead be 6 million ($15 million x 40%), saving 1.67 million in estate taxes.  The prior gift counts towards exhausting an individual’s available basic exclusion; however, the amount in excess of the basic exclusion existing at the time of death is not clawed back. 

Likewise, if the taxpayer in the example does not make the gift in 2018, assuming no growth on the 11.18 million and, therefore dying with 26.18 million in his estate and a 7 million basic exclusion, the estate tax is the same as without the anti-clawback legislation.  Therefore, the taxpayer, again, saves 1.67 million by leveraging the historical high exclusion before January 1, 2026.  Again, it is a “use it or lose it” savings opportunity in the next two (2) years. 

Leveraging the Annual Gift Tax Exclusion

The basic exclusion is the unified amount that can be used as a credit or deduction against gift and estate tax in accordance with Section 2010 of the Internal Revenue Code.  Quite differently, the annual gift tax exclusion is the amount specified in Section 2503 of the Internal Revenue Code that can be donated to an individual during the year without being considered a “taxable gift” and, therefore, without counting towards one’s basic exclusion or required to be reported to the IRS on Form 709.  This is a powerful tool to reduce an individual’s taxable estate.  Additionally, Section 2513(a)(1) provides that a gift made by one spouse to any person other than his or her spouse shall, for gift tax purposes, be considered made one-half by each spouse. Therefore, married couples can double their annual gift tax exclusion by gift splitting. 

The annual gift tax exclusion is $18,000 in 2024.  With gift splitting, married couples can gift up to $36,000 per recipient. The number of individuals who can receive a gift under the excludible amount is unlimited and, therefore, it can be especially leveraged for individuals or married couples with many lineal descendants or individuals to whom they intend to leave their assets.  If a married couple has five children and eight adult grandchildren, they could reduce their taxable estate, without using any of their lifetime exclusions, by $468,000 each year simply by making a gift of $36,000 to each child and grandchild.  The limitation to this strategy is that for individuals or married couples whose estate is well over the basic exclusion and who have few heirs, it may take many years to significantly reduce the size of their taxable estate. 

To learn more about estate tax planning, contact our office.

Estate Planning & Admin