Next year the amount exempt from the federal estate and gift tax will be $11.4 million per taxpayer. For a married couple, assuming that they both die next year, the exemption is doubled, to $22.8 million. This exemption is scheduled to fall roughly in half in 2026, unless Congress acts before then to make it permanent.

Reductions in the federal estate tax exemption have been scheduled before, but one has never happened in the history of our estate tax. If a reduction does take place, there is some concern about how that will work. The confusion arises because the federal estate tax is imposed based upon the sum of the lifetime gifts and the assets that the decedent still owns at death. Specifically, could a gift that was protected from the federal gift tax by the enlarged exemption amount be hit by an estate tax that would "claw back" the tax benefit?

To take an extreme and simplified example, Jonathan is worth $11.4 million. He makes a taxable gift of all of his assets in 2019, but owes no federal gift tax because the exemption amount covers it. Jonathan then survives until 2026, when he dies. Theoretically his federally taxable estate that year is $11.4 million (his lifetime taxable gifts), while the exemption will have fallen to roughly $5.5 million. Theoretically that suggests a federal estate tax of some $2 million could be due, even though the estate will have no assets.

Fortunately for taxpayers, the IRS has recently proposed new regulations to head off this possibility. Gifts that were free of transfer tax during the period of an enlarged exemption will stay tax-free forever, they won't be hit by a later estate tax.

The practical import of this development for those who have larger estates is that they should consider making substantial gifts before 2026 so as to "lock in" the benefit of the larger exclusion. The gift also locks in the taxable value of the transfer. However, the last time this advice was given it was proved to be unnecessary, so don't rush into any decisions.

(December 2018)
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