Estate Planning and the TCJA
Estate planners are once again preparing for the potential expiration of key tax provisions. In 2010, the federal government stepped in with The Tax Relief Act of 2010 to avoid the sunset provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 and then again in 2012 with the American Taxpayer Relief Act of 2012 to avoid the sunset provisions of the Tax Relief Act of 2010. Now, planners are looking straight into the sunset of another law, The Tax Cuts and Jobs Act of 2017 (TCJA). Since the November election results, it now seems likely that the President and Congress will once again step in to avoid it.
A Brief History: How Did We Get Here?
When the TCJA was enacted, it significantly increased the federal estate, gift, and generation-skipping tax exemption. The Tax Relief Act of 2010 had previously exempted estates from such taxes that were valued below $5,000,000. This 2010 threshold had been increased annually for inflation and was sitting at $5,490,000 at the end of 2017. With the enactment of the TCJA, the exemption more than doubled to $11,180,000 in 2018. Like previous exemption thresholds, the TCJA was indexed to keep pace with inflation and currently stands at $13,610,000 with the IRS just announcing an increase to $13,990,000 in 2025. Like previous tax laws, embedded within the expanded exemption thresholds of the TCJA was a sunset provision which reverts back to the 2010 threshold (indexed for inflation) on January 1, 2026, resulting in a likely federal estate, gift, and generation-skipping tax exemption of approximately $7,000,000.
Other TCJA tax provisions that are set to expire at the end of 2025 include:
- Increased annual deduction limits for charitable cash contributions to public charities.
- The reduction of the top individual income tax bracket.
- Elimination of the qualified business income deduction for pass-through entities.
Political Considerations
To avoid another sunset, Congress and the President will need to take affirmative action. Since the 2024 presidential election resulted in Republican wins for the President, the Senate, and the House of Representatives, it would be surprising if no affirmative action were taken to extend the TCJA. With Republican majorities in both chambers of Congress, an action to extend the sunset would almost certainly pass. President Trump is likely to extend the current estate and gift tax exemption rates under the TCJA or eliminate estate, gift, and GST taxes altogether. A mere simple majority in the Senate would suffice as any affirmative action to avoid the sunset would be part of a reconciliation bill that would not be subject to the Senate’s filibuster rules. However, given that the deficit is currently at $1.83 trillion, with an increase of $238 billion over the last fiscal year, while doubtful, Congress could let the TCJA fully or partially sunset to help address the deficit and potential spending.
Weighing the Options
But until an extension is actually passed, what is a planner to do? The future of the TCJA is still a question. This uncertainty makes tax and estate planning quite precarious. For planners advising high-net worth clients, the saying, ‘Expect the best, prepare for the worst’ may be most on point.
Planners are essentially at a fork in the road as 2024 nears its end: advise and plan as if the current exemption thresholds will remain or advise and plan as if they will disappear.
Strategies to Mitigate the Sunset
It’s important to consider that a Sunset extension is not a total given. Planning for a post-TCJA tax landscape requires careful analysis of a client’s financial forecast now and the implementation of certain strategies prior to the end of 2025. Here are 3 strategies for every planner to consider when seeking to mitigate the effects of a TCJA sunset:
- Maximize Use of Current Estate and Gift Tax Exemption
- Implement Charitable Giving Strategies
- Accelerate Income
Maximize Use of Current Exemption
The portion of the current federal estate, gift, and GST exemption amount that exceeds what the exemption amount will be after the sunset is truly a use it or lose it situation. Gifting now allows a client to gift over $13,000,000 and a married couple to gift over $26,000,000 without incurring federal estate taxes, which could be as high as 40%. Come the end of 2025, that same client and couple is likely going to be only able to gift $7,000,000 individually and $14,000,000 collectively without incurring federal estate tax liability. The $6,000,000 gifting opportunity vanishes without a trace. In addition, the IRS has updated guidance to affirm that making large gifts now will not harm estates in the event of a reduced tax exemption.
For example, if a client who is a U.S. Citizen with a net worth of $15,000,000.00 dies in 2026, the federal estate tax exemption of $7,000,000 will result in $8,000,000 being taxed at 40%, which would result in a tax liability of $3,200,000.00. However, if the same client gifts $5,000,000 before the end of 2025 utilizing their federal estate and gift tax exemption, their taxable estate would be $10,000,000.00 in 2026, which would result in only $3,000,000.00 being taxed at 40% reducing their tax liability to $1,200,000. Ideally, if the client in this example is able to gift $8,000,000, then they would have reduced their federal estate tax liability to zero, maximizing the gifts to their intended beneficiaries.
Outright gifts to descendants are an efficient way to use a client’s exemption. However, if outright gifting is impractical (such as a minor or incapacitated beneficiary) or undesired (such as a spendthrift beneficiary), then gifting strategies to maximize the current exemption include the use and funding of various irrevocable trusts, which allow the client to still choose who benefits from such gifting and under what parameters such beneficiary realizes a beneficial interest. Planners should consider:
- irrevocable life insurance trusts
- spousal lifetime access trusts
- irrevocable trusts for descendants.
When identifying assets in which to fund such trusts, planners should prioritize highly appreciating assets because once the asset is gifted to the trust and is outside of the client’s taxable estate, the appreciation arising from such asset is not includable in the client’s taxable estate.
Planners should not procrastinate when implementing funding strategies as it may take a significant amount of time to effectuate the funding of certain irrevocable trusts. For example, if a client wishes to create a spousal lifetime access trust for her spouse but all of her assets are jointly held with her spouse, such assets will need to be retitled and then transferred to the trust in a way and manner that would not risk inclusion via the “step transaction” doctrine.
Planners should also leverage valuation discounts, which can help a client maximize the number of assets transferred as part of any strategy to maximize the use of their current exemption. Discounting can range from 10% to 45% for various reasons such as lack of marketability, lack of control, or minority share. For example, if a client has a business originally valued at $5,000,000 and $10,000,000 in cash. In 2025, the client could only gift the business and $8,990,000 and avoid federal estate tax liability. However, if the client leveraged valuation discounts and the adjusted value of the business was $3,500,000 then the client could gift the business and all her cash without incurring federal estate tax liability.
Implement Charitable Giving
The TCJA increased tax deduction for charitable cash donations from 50% of the donor’s adjusted gross income to 60%. After 2025, this increased charitable tax deduction will sunset back to 50%. Consequently, for clients in a position to make significant charitable contributions, completing such contributions before the end of 2025 would result in an additional 10% of the client’s adjusted gross income that could be deducted from their taxable income. If cash is a significant source of charitable contributions for a client, then planners should consider incorporating charitable trusts created and funded prior to the end of 2025.
Accelerate Income
The highest income tax bracket was reduced to 37% in the TCJA. However, this rate will revert back to its previous rate of 39.6% after the sunset at the end of 2025. Therefore, any income received in 2025 will be taxed at a lower rate compared to 2026. In addition, clients will lose the qualified business income deduction after 2025 if the TCJA sunsets. Consequently, clients with income from sole proprietorships, partnerships, S Corporations, and certain trusts such as real estate investment trusts, will lose their ability to deduct up to 20% of their income from such entities. Planners should look for opportunities to accelerate income from such entities to 2025 or defer deductions to 2026. Individuals could also consider a Roth IRA conversion or whether it is beneficial to convert to C-corporation.
Conclusion
While we now know the 20204 Election results, and likely the fate of the TCJA, we still don’t know with complete certainty that there will be an extension. Planners would be wise to act now to prepare for the potential sunset of certain tax provisions. We have been here before, and because of this, we have learned many strategies to mitigate the tax consequences of a sunset. These strategies include maximizing a client’s use of the current exemption through gifting and trust planning, implementing charitable giving especially of cash contributions, and accelerating income to maximize income tax savings for the client. The clock is still ticking, and planners must act to carefully review existing estate plans and the financial portfolios of clients to determine how best to incorporate these strategies for their clients.
No strategy or combination of strategies will work for every client and KJK’s dedicated team of estate planning attorneys are committed to providing comprehensive services for individuals and businesses seeking effective solutions to prepare for the future.
Next Steps
With offices in Cleveland and Columbus, KJK’s estate planning attorneys are dedicated to providing comprehensive guidance tailored to your unique needs. To learn more or schedule a consultation, please contact an attorney in our Estate Planning practice group:
- Cleveland Office: 216.696.8700
- Columbus Office: 614.427.5731
We look forward to assisting you with securing your future.