Understanding Potential Estate and Gift Tax Threats

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Published on 7/29/2020

The tax debate has been going on for decades. Federal taxes especially have been lower for the past few years. The exemptions on the estate and gift taxes have extensive exemptions which have helped the well-off taxpayers immensely.

However, the golden period for these people may be coming to an end. The exemptions under the estate and gift tax could be lowered.

One of the primary reasons for this to happen is that the federal budget kitty is running low. It is affecting the Treasury and the Federal Government during the coronavirus pandemic with deficits. The Government is giving out relief money and exemptions, but it is hurting their budget. When the Treasury does its audit, it realises that estate and gift taxes were realms where they lost a lot of tax money by eligible taxpayers.

People are expecting the Government to further give out stimulus checks in the wake of the economic crisis due to COVID-19. Hence, a measure like lowering the exemption for estate and gift taxes could be reduced.

There are many supporters of the tax and others who want the tax exemption to be lowered. While there also are people who wish for the federal estate and gift tax to be abolished entirely.

An incident like this is potentially possible and highly likely to happen. And so, what would happen to those individuals who spent their entire lives accumulating wealth? Can they protect themselves from an imminent threat like the potential estate and gift tax threat?

What is the Federal Estate and Gift Tax?

The Estate and Gift Tax was brought in by the Tax Cuts and Jobs Act which aimed at giving a tax exemption on federal estate and gifts.

It is a unified federal tax which consists of estate and gifts tax. It includes gifts made during one’s lifetime and at death, gifts to charities and even between spouses. Hence, you can claim a tax exemption for gifts given in your lifetime.

At present, there is an annual limit for tax exemption when it comes to taxable gifts given in a particular year. You can provide an unlimited number of gifts to an unlimited number of people amounting to $15,000 per year and claim an exemption for it.

Previous Estate and Gift Tax bars

Following is an account of the previous federal estate and gift tax regime. Exemption refers to the tax exemption given on estate and gifts. Maximum tax rate refers to the tax percentage on the exceeding amount of the exemption.

2020

  • Exemption: $675,000
  • Maximum tax rate: 55%

2005

  • Exemption: $1.5 million
  • Maximum tax rate: 47%

2009

  • Exemption: $3.5 million
  • Maximum tax rate: 54%

2010

  • No federal estate tax bill 

2015

  • Exemption: $5.43 million
  • Maximum tax rate: 40%

2020

  • Exemption: $11.58 million
  • Maximum tax rate: 40%

The estate and gift tax have been favourable to the wealthy strata of the society. Each year, the exemption limit has been upped keeping up with the inflation costs. On the other hand, the maximum tax rate has been reduced each year, giving relaxation to the well-off taxpayers.

Sunset Provision Scheduled for 2026

For the year 2026, the Sunset Provision will provide the exemption for the year 2026. Consequently, the exemption for 20206 under the federal estate and gift tax will be the same as that in 2017- $5.49 million. The exempted amount for 2026 can be adjusted for inflation.

If the Sunset provision doesn’t take place, the exemption is pegged at $6.5 million. However, the maximum tax rate will remain fixed at 40%.

The Portable Exemption Privilege

It is essentially a spousal privilege which was introduced in 2011. The portable tax exemption is applicable only on married couples. So, if one spouse dies without using their tax exemption, the unused exemption can be inherited by the surviving spouse.

Subsequently, if the other spouse also dies within a year, the cumulative exemption of the couple will be inherited by the couple’s children.

The Looming Threat

The threat on the federal estate and gift tax is haunting the taxpayers who rely on this exemption.

There is a good chance that this tax exemption could come to an end very soon. The entire Bill could be quashed, giving no exemption on estate and gifts made.

The tax exemptions could be lowered. We could go back to the regime in 2000 or 2009. 

That would be the worst with low tax exemptions, high maximum tax rates and no portable exemptions.

Or the incumbent regime could be replaced by something which might not go well with the taxpayer.

What can you do to protect your assets?

If you are married, you get the benefit of combining your and your spouse’s exemption to work for you.

See if you can get the portable exemption work in your favour if your spouse passed after 2010.

If you are someone who has a large estate/property and has never made any gifts; you could go on a gifting spree to protect your assets. You can give money as gifts to your children or next of kin you trust with a mutual, verbal understanding of it belonging to you.

Yes, it is highly unreliable, but so is the future. It is a gamble you have to play, but you have no other choice working out for you in your favour.

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