When the Tax Cuts and Jobs Act of 2017 was passed, one of the benefits for wealthier families was the doubling of the federal gift and estate tax exemption. With inflation adjustments, it’s currently $11.58 million per individual, which means a married couple could transfer over $23 million without incurring a federal gift tax in 2020, or no federal estate tax if they both died in 2020. New Jersey eliminated its estate tax for people that passed after January 1st 2018, but still imposes an inheritance tax based on the relationship between the decedent and the receiver. More information on the NJ inheritance tax can be found here.
The doubled federal exemption is currently set to drop roughly in half in 2026, so one might think there is plenty of time to take advantage of it, but laws can and have changed in the past. It’s possible the law will change before 2026 and that benefit will disappear. It’s also possible it will become permanent. We can’t know what change will be coming up for sure, but we can know what can be achieved though actionable steps available today.
For a quick example –
Let’s say a husband and wife own a large farm business that’s valued at $30 million, farming asparagus which flourishes in our garden state, and have a daughter they are grooming to take over the business. At the current exemption, they could give her ~$23 million without any federal gift tax, and the remaining $7 million would hit the top tax rate of 40%, so the gift tax would still be $2.8 million. The daughter is a Class A beneficiary in NJ, so no state inheritance tax is owed if they wait until death for the transfer. In that case they should consider life insurance to ensure that there are enough liquid assets to cover that tax, so that the business doesn’t need to be dismantled or take on more debt.
Alternatively – Let’s say the exemption falls to $3.5 million (one figure that was considered in the past). The scenario gets reversed, and only $7 million is exempt. The 40% tax rate is applied to the ~$23 million balance, creating a potential tax liability of ~$9.2 million. This difference of $6.4 million in tax liability will make a large impact on whether or not the daughter is able to maintain the business.
One shouldn’t be trying to time one’s death, but one can time the transfer of assets.
By transferring the assets in 2020, one can lock in the larger exemption amount. However, that would mean transferring the assets, which is a step many are not willing to take until circumstances makes it necessary.
Small gifts add up over time!
There are risks involved when you lose control of your assets. For many estates, the difference would not be as substantial as in the example above, and the possibility of tax change is speculative. However, there is another tax benefit to take advantage of in estate planning called the annual gift tax exclusion. It’s currently set to $15,000 per recipient.
This means that someone can give as many recipients as they’d like $15,000 each year without incurring tax liability. This may not seem like a lot, but if there are many recipients and it’s done over time, it can really add up. For married couples, each partner can make a $15,000 gift, so a husband and wife could give $30,000 in a year to their child together.
Here’s a quick example (we’ll assume the current tax rate, but that may change in the next ten years):
Two grandparents want to support all their progeny. They start by providing the maximum gift tax annual exclusion amount to their four children and 12 grandchildren in 2020 and subsequent years, and add in 4 additional great grandchildren in 2025 until 2030. That’s $480 thousand each year given for five years, and $600 thousand for the second five years. Total gifts of $5.4 million may be made with no tax liability over the ten-year period. The example becomes substantial because there are so many recipients that they are supporting.
Let’s say the estate is still large enough that the 40% estate tax rate is incurred. The $5.4 million taken out of the taxable estate avoided $2.16 million in federal estate taxes for the estates of the parents.
One final wrinkle. Let us assume that the grandparents will have to sell appreciated stocks or other assets to fund such generosity. In doing so, they will incur federal and state taxes on their capital gains, which could be quite substantial. The alternative is to make a gift of the appreciated assets, such as $15,000 worth of shares of stock. Those receiving such shares will take the tax basis of the grandparents, and so they in turn will be exposed to a capital gain tax when they sell. However, they may be in a lower bracket than the grandparents—as low as 0%!
The professionals at Garden State Trust Company would be pleased to go over your estate planning with you, and explain how these strategies and others may be appropriate for your situation.
