Shining Some Light on the Sunset

Written by Phoebe Stone, JD, MA (Bioethics) on August 8, 2024

Exemption amounts for gift, estate, and generation-skipping transfer (GST) taxes are at historically high levels as of the writing of this article. However, absent congressional action, these exemptions are scheduled to revert to pre-2017 levels ($5 million adjusted for inflation) as of January 1, 2026, under the terms of the 2017 Tax Cuts and Jobs Act (TCJA). This is what is referred to as the coming “sunset.” Even if this dramatic decrease occurs as scheduled, the vast majority of American taxpayers are still likely to have estates below federally taxable thresholds. However, the sunset is likely to impact higher-net-worth clients, who may wish to take action now to preserve the benefits of the historically high exemptions. 

The current anticlawback rules provide peace of mind that, if the exemption amounts decrease as scheduled, transfers made now in excess of the anticipated lower limits will be grandfathered in under the old rules. In other words, if clients make large transfers now (in order to take advantage of the historically high exemptions) and then die after December 31, 2025, they will not be treated as having made taxable transfers in excess of applicable post-2025 exemption amounts. Thus, a large part of planning for the sunset rests on taking full advantage of historically high exemptions by making large transfers before 2026, while large transfers can be made without adverse tax consequences. Put differently, a primary sunset-planning technique is to decrease the estates of wealthy individuals during 2024 and 2025. 

Learn more by registering for the webinar, Shining Some Light on the Sunset, taking place on Thursday, December 12, 2024, 1 PM - 2 PM, ET

Transfer Tax Primer

In their most basic form,

• the federal estate tax is a tax on property transferred at death, 
• the federal gift tax is a tax on gifts made during life, and 
• the federal GST tax is a tax on transfers that skip a generation (e.g., from grandparent to grandchild) that can be imposed on lifetime gifts or bequests at death.

Federal estate taxes are only imposed on estates that exceed an applicable exclusion amount (AEA), so only estates over a certain size are taxable. The AEA in turn is based on the basic exclusion amount (BEA), which is a threshold that varies annually due to inflation adjustments or acts of Congress. The federal gift tax and the federal estate tax are unified such that gift  givers must keep track of any lifetime gifts made in excess of the annual gift tax exclusion amount (which is another threshold that varies annually based on adjustments for inflation or acts of Congress). These large gifts eat into the BEA available to the gift giver upon death. If the gift giver exceeds the available exemptions with lifetime gifts, they are generally responsible for paying the tax on those transfers. The federal GST tax is imposed on intrafamily transfers that skip a generation (e.g., grandparent to grandchild) and on transfers between unrelated parties if the gift giver is more than 37.5 years older than the gift recipient. The GST tax applies to both lifetime gifts and bequests. 

An important concept related to the federal estate tax is portability. Because the BEA changes annually, portability can be an important estate planning tool for married couples. Portability is the ability of a surviving spouse to “port” (or pocket) a deceased spouse’s unused exclusion amount (DSUE) to add it to the exclusion available when the survivor later dies. This effectively increases the AEA available to the survivor’s estate because AEA equals BEA plus DSUE. Thus, if a spouse dies while the BEA is high, electing portability allows the survivor to potentially avoid estate tax liability by pocketing and saving for later any DSUE, which can then be used to augment the BEA available in the survivor’s year of death. 

Historical Context

The Sixteenth Amendment to the Constitution, ratified in 1913, gives Congress the right to “lay and collect taxes on incomes, from whatever source derived.” Three years later, the Revenue Act of 1916 marked the inception of estate taxation. In the 1920s, the government created and instituted gift taxes to tax gifts made during life. This tax was repealed, modified, and reinstated in the 1930s. In 1976, the estate and gift taxes were unified, and GST taxation was implemented. The GST tax was modified in 1988, and since 2010, the GST tax exemption and the BEA have been equal in amount—although they are entirely separate taxes. In 2010, the estate tax briefly expired; otherwise, the gift tax annual exclusion, the BEA, and GST exemption amounts have increased (or remained stable) since 1976. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 fixed the estate tax, gift tax, and GST tax exemptions at $5 million (adjusted annually for inflation). The TCJA doubled the estate tax, gift tax, and GST tax exemptions, which continue to be adjusted for inflation. However the increase in these exemptions is scheduled to sunset at the end of 2025. The impacts are summarized in the table below, which shows selected metrics from this century. 

Given the uncertainty about whether the high exemption amount will sunset as scheduled, estate planners and clients alike may be wondering what (if anything) they should do now to take advantage of the historically high exemptions and prepare for the sunset. The following discussion presents some options.

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