As we enter autumn and move closer to the holiday season, it’s natural to pivot our thinking towards gifts. But have you ever considered the role that gifting can play in effective year-end financial planning?
As a foundation, let’s briefly discuss the transfer taxes in place at the federal level:
- The gift tax.
- The estate tax.
- Generation Skipping Transfer (GST) taxes.
The gift and estate tax applies to transfers that take place either during one’s lifetime or at death. The GST tax may apply to transfers to grandchildren, more remote descendants, and other younger individuals. The tax code provides exemptions to these taxes. Among them are the gift and estate tax exemption (also known as the unified credit or lifetime exemption) and the GST tax exemption.
Looking back to 2017, Congress passed a bill that contained sweeping tax changes. Among them was an increase in the lifetime gift and estate tax exemption amount and the Generation Skipping Transfer tax exemption amount. Specifically, the lifetime exemption doubled from $5.49 million, that was available in 2017, to $11.18 million in 2018, and this amount adjusts annually for inflation. For 2023, the lifetime gift tax exemption amount stands at $12.92 million, which essentially means that taxpayers can gift up to this amount without having to pay a gift tax.
Widowed taxpayers may also be able to take advantage of spousal portability. This means that a surviving spouse may have access to an additional estate tax exemption amount at his or her death as the result of an unused estate tax exemption amount from the deceased spouse.
Given that the current “double” exemption amounts are due to sunset on 12/31/2025, and revert to prior levels beginning on January 1, 2026, individuals and married couples with estate values over $6.46 million (or $12.92 million combined for a married couple), should consider taking advantage of the gift tax exemption now as it may save their estates sizable amounts in future federal estate taxes.
This brings us back to the topic of gifting and how it may help you with your estate planning needs. By “gifting away” personal assets now, you can, in effect, “freeze” the value of the assets for gift/estate/GST tax purposes. This means that should the assets appreciate in value after they’ve been gifted, your estate or beneficiaries will not owe additional gift/transfer tax on the appreciated amount, and any future appreciation is removed from your estate, thereby saving your beneficiaries a potentially large amount in future estate taxes.
As an example of how MassMutual Private Wealth & Trust can help high-net-worth families with their estate planning needs, I am currently working with a client to whom I have recommended gifting assets now in order to take advantage of the estate freeze. In this particular case, the client and spouse own shares of closely held company stock. The client and company management team are working through different scenarios in which a sale of the stock is likely to occur in the next few years, at a significant increase in valuation. We are discussing gifting strategies that include a combination of irrevocable trusts for the benefit of their children, as well as Spousal Lifetime Access Trusts (SLATs) (discussed below) to potentially save the family $20 million to $32 million in eventual estate taxes.
Estate planning strategies
While every client and their family have different needs when it comes to structuring estate plans, the following is a high level overview of some commonly used strategies for estate planning.
- Outright gifts; simple, straightforward and easy. This type of gifting does require the preparation and filing of a gift tax return, however, if the gifted amount is over the available annual exclusion ($17,000 for 2023).
- A gift to a lifetime irrevocable trust for the benefit of children/grandchildren or other beneficiaries. This type of gifting enables the giver to utilize both the gift tax exemption and the Generation Skipping Transfer tax exemption. (Related: Is setting up a trust right for you?)
- Spousal Lifetime Access Trusts: Both spouses can execute trusts, and as long as the terms of the trusts are different, the reciprocal trust doctrine, whereby the IRS disregards the trust entity for estate tax purposes and the assets of the trusts continue to be includible in the taxable estates of the grantors, is avoided. This strategy allows spouses to take advantage of exemptions while allowing the other spouse (and children) to have access to the trust income and/or principal.
- Defective Grantor Trust: SLATs are always grantor trusts while other lifetime trusts can be structured this way. For high-net-worth and ultra-high-net-worth families, the grantor continues to bear the income tax responsibility for the trust. The annual income tax payments, on top of the gift and freeze technique, are additional annual gifts that are not subject to gift or estate taxes. The grantor also slowly reduces the size of his/her remaining taxable estate with the help of this strategy.
- Annual exclusion gifts: The IRS allows taxpayers to gift $17,000 per year to anyone, without the need to file a gift tax return and without using any lifetime exemption. A married couple can combine the exemption and give up to $34,000 (a gift tax return may be required if gift splitting). Utilizing annual gifts allows clients to transfer additional assets to their loved ones without incurring any tax implications. Over the long term, these gifts can greatly impact a client's estate.
What if a client has already used all available exemptions?
While this article focuses on gifting within the exclusion limits, there may be situations where making a taxable gift makes sense. For example, for ultra-high-net-worth taxpayers, it may be more tax efficient in the long run to make taxable gifts and pay gift tax during life rather than to pay transfer taxes at death.
In addition to exploring strategies such as outright gifts, other more sophisticated strategies such as Charitable Remainder Trusts, Charitable Lead Trusts and Grantor Retained Annuity Trusts are available based on your personal situation and needs. Together with your financial professional, MassMutual Private Wealth & Trust can recommend strategies that may be most beneficial to you.
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