Ep. 10: 2023 Federal Estate And Gift Tax Basics

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If you give gifts on an annual basis, its important to know the rules to avoid ending up crossways with the Internal Revenue Service.

For those with large estates, there is an exciting opportunity to do some planning prior to the sunset provisions kicking in on January 1, 2026, which will substantially change the laws.

While todays discussion focuses on federal law, its important to know what applies to you on the state level.

Each of our 50 states can, if they wish, impose their own estate tax, inheritance tax, or gift tax. In 2023, there are 12 states with an estate tax. This means when a person dies, the government levies a percentage tax on the assets that are owned at death.

Six states have an inheritance tax, which taxes the person receiving the inheritance rather than the actual estate. The good is that there is only one state, Connecticut, which has a gift tax.

With all that in mind, how can you navigate the often-confusing federal gift tax laws, particularly when it comes to the annual exclusion gift” and the lifetime exemption amount?” Finally, what planning opportunity can you take advantage of between now and December 31, 2025? Listen in and find out!

Key Topics:

  • State laws concerning estate, inheritance, and gift taxes (0:58)
  • Federal law, the “annual exclusion gift,” and the “lifetime exemption amount” (3:34)
  • What to expect when the sunset provisions kick in on January 1, 2026 (8:11)
  • A planning opportunity to consider prior to December 31, 2025 (9:59)
  • Which assets can be transferred into a trust? (12:43)
  • Transferring an unlimited amount of money for medical expenses or for tuition (16:40)
  • Fair market value determines your gift amount (19:43)
  • Closing thoughts (21:03)


Transcript: Prefer to Read — Click to Open

Welcome to today’s show. This is episode 10 – 2023 Federal Estate and Gift Tax Basics. Well, why is this so important? A couple of things, for those of you who are making gifts on an annual basis to family members, you need to know what the reporting requirements are and what the rules are, so that you do not end up getting crossways with the Internal Revenue Service. One cardinal rule that I have learned in my 36 years of practicing law, is that we want to make sure that we follow the IRS rules so we do not run counter to those rules, much easier to understand the rules and then comply with them, because the last entity you ever want to have a fight with is the Internal Revenue Service, that is number one. Number two, though, for those of you who have large estates, there is an exciting opportunity for you to do some planning, prior to the Sunset Provisions kicking in on January 1 of 2026, which are going to substantially change the rules. We are going to talk about those planning opportunities as a part of this episode. Let us start with some of the basics.

First of all, today, I want to focus on federal law, but before I do that, I do want to just briefly touch upon state law. Just remember, we are the United States of America, there are 50 states out here who can, if they wish, impose their own estate tax, inheritance tax, or gift tax. Now here in 2023, at the present time, there are 12 states that have an estate tax, that is that when a person dies, they are going to levy a percentage tax on the assets that are owned at death. 12 states will do that, some of those states include Minnesota, Hawaii, Washington, New York, Illinois. That is just a handful of the 12 states that will still tax an estate. As you can see, the vast majority of states have eliminated their estate tax. There are six states though that have an inheritance tax.

Now, what’s the difference between an estate tax and an inheritance tax? Well, the inheritance tax is taxed to the person who receives the inheritance versus an estate tax, which is taxed to the actual estate. Similar concepts may have the same result in most cases, but not all cases. So, there are six separate states that have an inheritance tax. The good news is there is only one state Connecticut, which has a gift tax.

Now let us talk briefly about Federal Law. It seems as though every client that I meet in my office is really confused about the Federal Gift Tax. In particular, they are confused by what is commonly called the annual exclusion gift and the lifetime exemption amount and how these two concepts interrelate one with another. Well, what the law says is that there is an annual exclusion amount for 2023. This amount has been increased to $17,000 per person that you can make gifts to, and by the way, you can make $17,000 annual exclusion gifts to an unlimited number of people. In addition, if you are married, your spouse can do the same. So, that you can gift in 2023 up to $34,000 by utilizing your annual exclusion amount, that is the annual exclusion amount does not have to be reported to the Internal Revenue Service on a gift tax return if the amount to that person stays under that amount. Having said that, please understand that if you gift more than $17,000 per person, there is no gift tax that is owed, and that is what most people do not understand. All the requirement is is that if you go over the 17,000, when you file your income tax return on April 15 or before, you need to include another form called a 709 Gift Tax Form and simply report the gift to the Internal Revenue Service. When you report a gift, above and beyond the annual exclusion amount, just think of it as if the IRS maintains a log of all of your gifts, and the amount that exceeds the annual exclusion amount simply gets subtracted from your lifetime exemption amount. What is important to understand is that that lifetime exemption amount has been substantially increased each year, and will continue to do so until January 1 of 2026. For instance, the lifetime exemption amount for 2022, has been raised for 2023, up to $12.9 million. That means that you as an individual are allowed during your lifetime or at death, to transfer $12.9 million to your heirs, and if you are a married couple, it is double that amount. So, it is extremely important that we understand the difference between the annual exclusion amount and the lifetime exemption amount. As you can see, with some good planning, you can make annual exclusion gifts that are not subtracted from your lifetime exemption amount. Remember, only those that exceed the $17,000 amount gets subtracted from your lifetime exemption amount, and your lifetime exemption amount is increasing each year due to inflation. Now, the tax rate once you exceed the exemption amount is a flat 40% tax rate, and that has been the case for several years. Previously, it has been as high as 55%.

Now, let us talk a little bit about what is going to happen and why on January 1 of 2026. Well, when the Jobs Act was passed by Congress, they enacted a variety of tax decreases, but did not have enough sense or fortitude to pay for those tax cuts, and under the current law, if congress adopts tax cuts, but does not pay for them, then that tax cut law has to sunset after 10 years, and that is what is playing out here. That is that the tax cuts that were previously adopted are going to expire on December 31st of 2025, and therefore, we are going to go back on January 1 of 2026 to the 2015 lifetime exemption amounts subject to an increase for inflation. Depending upon the inflation rate, that new amount on January 1 of 2026 is likely to be somewhere around 6.5 to $7 million per person, still a significant amount, but a substantial reduction, basically a 50% reduction. Now, the good news is, is that there is a tremendous planning opportunity for those of you who have a taxable estate, that is for those of you who have an estate, if you are a single person that exceeds the 6.5 or $7 million amount, or a married couple which exceeds the 13 to $14 million amount, because remember, unless Congress acts, effective January 1 of 2026, if you pass away, if you are a single person, there will be a 40% tax on every dollar over that amount.

So, what is the planning opportunity? Well, here it is. As I indicated, the current lifetime exemption amounts are going to get cut in half. But between now and December 31, of 2025, the IRS has indicated Congress adopted what are called the Anti-Clawback Measures. These measures say that if you make a transfer now, or prior to December 31st, 2025, you are allowed to utilize the current amounts that are in effect, and if you die later, when the exemption amount is cut in half or lower, the IRS will not claw back those gifts, and make it subject to the Federal Estate Tax. That is a huge opportunity. Think about this, if I have a $12 million estate today, and let us say it grows at a rate of about 5% per year for 10 years, that estate, will be worth a little less than $20 million. So, think about it this way, if we take a $12 million amount, and make a lifetime gift, that is permissible under the current law, and not subject to attacks, and put it in an appropriate trust for the benefit of our heirs, for the benefit of our family, and we do it today before the law changes, more likely than not that $12 million gift will result in a $20 million gift in 10 years, and when we pass away, say in 10 years, 100% of it will be tax free because of the Anti-Clawback provisions that Congress adopted. Many of our wealthy clients are taking advantage of this unique provision, this unique Anti-Clawback provision, which allows them to make transfers now, in 2023, 2024, and 2025. I am often fond of saying that the time to repair the roof is when the sun is shining. Well, this is one of those occasions where if the sun is shining in your life, now is the time to seriously consider making a transfer into a trust. Now, we do want to be careful about what assets are transferred into a trust, what assets are gifted, and by the way, it is not an all or nothing proposition. I have clients of mine who are transferring 3 million or 6 million. It does not have to be the full exemption amount, but we do want to be careful to understand what assets are appropriate for gifting and other assets that we have to pay a little more attention to. So, if we can, we want to transfer assets that are not highly appreciated. In other words, if an asset has grown substantially during our lifetime, we may not want to transfer that particular asset if we have other assets that we can transfer. Well, why would that be? Well just remember that when we make a transfer during our lifetime, the basis of that property is carried forward. It is called carryover basis to the member of our family who receives that gift or to the trust that receives that gift. So, if we buy stock at $100, and it increases in value to $500 during our lifetime, but we transferred away through making a gift, the tax basis that the new owner will receive is our basis, the $100. There is no step up in basis when we make lifetime transfers. A step up in basis only occurs at death, and we must have that asset in our taxable estate in order to get that step up in basis. So, in my example, if we did the lifetime transfer, where we had purchased it for 100, but it is worth 500, the carryover basis is going to be 100. If we hold that asset until we die, and let us say it is still worth $500 when we pass away, our children’s tax basis in that asset, then will be $500. Point being if they sell that asset, and the tax basis has stepped up, they will pay no capital gains tax. On the other hand, if we have gifted the asset, and they transfer it, they will pay a capital gains tax.

Now it is important to understand though there is a significant difference in the tax rates between the two. That is that if that asset remains in your taxable estate, and is subject to the Federal Estate Tax, it is a 40% tax. On the other hand, if you transfer it to a child or to a trust for a child, and they end up having to pay capital gains tax, they are only going to pay a 20% max capital gains tax rate, they may pay a 15% capital gains tax rate depending upon their tax bracket. I suppose in theory, depending upon their bracket, it could be lower than that, but you should probably pretty well plan on it being either 15% or 20%. But the point is that the Federal Estate Tax rate certainly is higher at 40% than the capital gains tax rate if it is ever sold. Obviously, the capital gains tax is never paid unless the asset is sold, a critical distinction.

The other thing I wanted to point out is that in addition to lifetime transfers being subject to the annual exclusion amount, and being exempt from having to be reported, please understand also, that you can transfer an unlimited amount of money to pay for medical expenses or for tuition for your family members. Those are not subject to being subtracted from the lifetime exemption amount just like the annual exclusion amount, the medical expense, and the tuition are in addition to your lifetime exemption amount, and a lot of people are a bit confused by that.

One other point, it is important that if you are a small business owner, and you want to transfer your business to your family members during your lifetime, that you understand that these gift tax rules, these estate tax rules are operative on the fair market value of your business. The fair market value of your business is determined oftentimes by an appraisal by a qualified person who is going to tell us what a willing buyer in an arm’s length transaction would pay for that business. I recently had an example come across my desk where a business owner sold his business which may be worth over $10 million, probably much more than that, sold that business to family members for under a million dollars, and then worked with the CPA, who said that we do not have to report anything to the IRS by way of a gift because in the CPA’s opinion, the book value of the company did not exceed the purchase price. Hold on here, that is not where we want to go. Any type of gift, and it could be, in this instance, a partial sale and a partial gift, but that gift amount is determined by the fair market value. It is not determined by the client simply saying, “Well, I am going to sell it to my kids at this value, and therefore, I am going to use that value to determine whether I do or do not have to file a gift or an estate tax return.” That is not going to work. We have to recognize that both the gift tax rules and the estate tax rules require us to determine the fair market value that is being transferred, and if some of it is being purchased, the other part of that may very well be a gift that will require lifetime reporting.

One of the significant advantages for reporting a gift or a transfer during our lifetime, is that the statute of limitations is only three years if we file the Federal Estate Tax 709 Gift Tax return. If we do not file a return, like the example I gave you with a small business owner, then there is no statute of limitations which will run and upon the parent’s death, and if a gift or estate tax return is filed at that time, it can be called into question and the value of the business can be subject to scrutiny by the Internal Revenue Service. That is certainly not somewhere where we want to be.

Well look, this is intended to be just a real basic primer on 2023 Federal State and Gift Tax rules. I hope that you have found this to be informative. I hope it will provide you with some clarity, and for those of you who have large estates, I hope this will provide you with some confidence with respect to making sure that between now and December 31 of 2025, you consult with an estate tax planning attorney who can show you what your options are, to be able to save substantial dollars for the benefit of your family. There is significant opportunity in doing some planning for your family. Whether that be setting up trusts for your spouse, or setting up trusts for your children or grandchildren, it even can involve doing some discount planning, depending upon how it is established.

Well, that is it for today. A cold, rainy winter day here in Dayton, Ohio. I wish all of you well. Until the next time, have a great day. Thank you so much.

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