An unprecedented wave of giving up wealth is emerging, with participants not just billionaires.
The tax reduction policy implemented by Trump in 2017 temporarily doubled the amount of personal inheritance tax free gifts to $10 million. These tax cuts will expire in 2026, prompting wealthy Americans to act quickly.
According to recent statistics released by the Internal Revenue Service, they donated $182.6 billion in 2021, more than twice the previous year's $75.2 billion in gifts. Among these donations, nearly $100 billion is completed through trusts, some of which can be extended for several generations. An additional $14.8 billion was donated to charitable organizations.
The financial advisor stated that for American households with net assets exceeding $10 million, there is an urgent need to consider taking a series of measures before the tax reduction policy expires. They face multiple choices, ranging from giving directly to heirs or establishing complex trusts to ensure that future generations continue to enjoy wealth. Otherwise, there is only one way to avoid high taxes: to die before the tax reduction policy expires.
We currently have an excellent opportunity to transfer tax-free assets, "said Shamisa Zvoma, a registered accountant at Wiss, an accounting firm in Floram Park, New Jersey.
The $10 million tax exemption in the 2017 Trump tax reduction policy is linked to inflation. In 2023, the total amount of gift and inheritance tax exemptions for each person reached $12.92 million, and the total amount of tax exemptions for each married couple was $25.84 million. This is the amount you can give to others during your lifetime or death without paying taxes.
Proskauer's estate lawyer Peter Tucci estimates that the tax exemption limit may be adjusted to $13.61 million next year. By 2025, the tax exemption limit for each person may increase to $14 million, followed by a sudden halving to around $7 million by 2026.
The estate planner stated that 2025 will be the last year for the tax reduction policy to expire on December 31 of that year, using the highest tax exemption amount in history to donate property.
Tucci stated that if a couple uses all the tax exemption before the tax reduction policy expires at the end of 2025 and transfers $28 million to someone else, it means that if they die in 2026, they will save $5.6 million in taxes. If they skip a generation and give this money to their grandchildren, it will save nearly $9 million in taxes.
Over time, this saved tax will significantly increase. When the funds in these trusts increase, the appreciation is not affected by the transfer tax system. Therefore, if the trust value increases by $100 million when the donor dies, at the current 40% tax rate, the family will save $40 million in estate tax. This is just a federal tax savings. In states such as New York that levy additional inheritance taxes on their own, they can also save on state inheritance taxes.
According to global wealth reports by economists at UBS and Credit Suisse, there are approximately 1.5 million Americans with net assets between $10 million and $50 million, and nearly 125000 Americans with higher net assets.
What is the simplest way to reduce inheritance by giving it to others?
Giving cash or securities directly is the simplest. In 2023, the annual limit for tax-free gifts is $17000, which may increase to $18000 by 2024. This means that anyone can give up to $17000 to an unlimited number of people without paying taxes. These gifts are not included in the gift tax and inheritance tax exemption limit of up to $12.92 million.
If the amount you give exceeds $17000, you usually have to fill out Form 709 to report to the IRS.
Caroline McKay, a senior wealth strategist at CIBC Private Wealth in Boston, said that she has some clients who give gifts to a large group of relatives, including grandchildren, nephews, and their spouses, so that they can cut hundreds of thousands of dollars from their inheritance each year.
This issue is particularly complex when long-term holdings of stocks have already appreciated. The cost base of the gift recipient directly comes from the original cost of the gift recipient's stock, and they are required to pay capital gains tax when selling the stock. If the tax rate applicable to the recipient is low, then there is no problem. Otherwise, it is best to hold these stocks until death, when their cost base will increase.
Under what circumstances do assets need to be gifted through trust?
For individuals facing inheritance tax, donating assets to a dynastytrust can preserve more wealth for their children. McKay said that this trust can transfer assets from your and your children's inheritance. The beneficiaries of these trusts are usually children, but there are also grandchildren and future generations.
Trusts can also provide property protection. Tucci said that if you hand over your assets directly to your children, they will lose some or all of their assets if they are sued or divorced. In contrast, if you give assets to a trust, it is more difficult for creditors to recover the trust principal.
One drawback of this type of trust is that it still requires capital gains tax and other income taxes, and these assets will not receive a new higher cost base upon the death of the donor.
The impact of the expiration of Trump's tax reduction policy
There is a possibility that higher inheritance tax exemptions may be extended or permanent. William Gale, a senior researcher on taxation and fiscal policy at the Brookings Institution, said that even if the Democrats controlled Congress during Biden's presidency, they did not lower the threshold for inheritance tax.
He said, "Throughout history, Congress has always decided to let the deficit widen
Republicans have long advocated for the abolition of the estate tax. The Democratic Party calls for strengthening this tax: reducing the tax exemption to $3.5 million, raising the maximum tax rate to 77%, and imposing a capital gains tax on the death of donors. They also called for restrictions on dynastic trusts. (There were 2584 federal estate tax returns submitted in 2021, bringing in $18.4 billion in tax revenue.)
Tucci said, "You must assume that the tax exemption limit will decrease." He pointed out that if you expect the tax exemption limit to remain at $14 million in 2026, you are gambling and you may lose a lot of tax savings that could have been made.