The Tax Cuts and Jobs Act (the “ACT”) had doubled lifetime gift and estate tax exemption amount from $5.49million to $11.18 million per individual. This exemption is indexed for inflation, and it increases annually based on the cost of living. Moreover, the exemption is $12.06 million per individual in 2022, up from $11.18 million in 2018.
The increase, however, is temporary and is set to expire and revert to its 2017 pre-ACT level (still indexed for inflation) beginning on January 1, 2026. This is called the “Sunset” clause. The exemption amount in 2026 will be about $6 million per individual.
This “Sunset” clause drives the rich group out of their comfort zones and gives them a big headache: How can I best utilize the current high gift and estate tax exemption amount before 2026?
Case study 1:
Mr. Wang and Ms. Li are a 50-year-old couple with $20 million asset. They came to us for estate planning solutions.
They expressed that they live a simple and modest lifestyle; they do not want to leave much asset to their heir or any other beneficiaries; and currently have no charitable giving plans. They are worried about 2026 estate tax exemption amount “Sunset” clause and would like to see what options are available to them for estate tax mitigation purpose.
We told Mr. Wang and Ms. Li that given the information they shared with us; they have no other options but to leave the money to IRS.
Why? Because for every penny you own, there are only four places the money can go:
- Personal spending
- Philanthropic donation
If you have no personal spending needs, no intention to leave money to any beneficiary or charity, then the only place that your estate money can go, will be IRS. Is this what you want? Most people would say no.
Therefore, before you pay thousands of dollars to any estate attorney or financial advisor, or jump into any nitty-gritty planning document details, please take some time to think about this: do you really know what you want to do with your money? Or to whom you would like to leave your money to?
Case study 2:
Mr. Zhang and Ms. Zhao are a 50-year-old couple with $15 million asset.
Unlike the couple mentioned in the previous case, Mr. Zhang and Ms. Zhao are very sure about what they would like to do with their money: leave everything to their only child, Donovan.
Donovan is like every parent’s dream kid: straight A student, mature and calm, over-achieving in almost everything, and is currently a junior at Harvard Business School.
Given 2026 “Sunset” clause approaching, Mr. Zhang and Ms. Zhao executed their plans without any hesitation: They gifted away almost everything they have to various trusts, and of course, with Donovan being the trust beneficiary. In addition, they gifted $3 million dollars directly to Donovan. After all estate planning documents are signed, Mr. Zhang and Ms. Zhao are left with a primary home and $100,000 cash only, but they are happy about their decisions.
Until they learnt that Donovan spent all $3 million dollars on NFT, cryptocurrency, and GME stock.
Mr. Zhang and Ms. Zhao strongly disagree with this “all in Metaverse” strategy and asked Donovan to return the $3 million dollar gift back. To their great surprise, Donovan bluntly said “No”, with his reason being:
- Metaverse is the future of everything. We cannot miss out on this opportunity.
- $3 million are already gift to him for the amount is not included in his parents’ estate. It does not make sense to gift the money back to be included in his parents’ estate again.
Mr. Zhang and Ms. Zhao were so shocked that they could not speak. This is one lesson they learned in the hard way: No matter who you choose to give away the asset, you should consider it is gone since the ownership has changed. You may think your child will give it back if you ask, because you were the kind parent who generously gift it to them, but they don’t have to if they don’t want to.
Gifting to your children can be a great way to reduce estate taxes if your estate is large and you can afford to give away an asset. However, gifting away to your children too soon can create problems that is against your wish: they could sell or invest the asset that you do not like, or they could lose all of it to creditors, or they could be influenced by a spouse you barely know. If you outlive your children, or they get a divorce, the daughter- or son-in-law could end up owning the asset you gifted away to your children. Would she or he give it back to you?
That’s why dynasty trusts are commonly adopted by financially comfortable families: by only gifting away the earnings to the beneficiaries, the principal amount is still protected in the trust. Make sure you consult with an experienced professional before making a substantial gift.
Case study 3:
Mr. Yang and Ms. Zhou are a 50-year-old couple. They believe they’ve done a great deal of homework: they know exactly to whom they will leave their money to, and they know exactly when they would like to gift away their money. Now the question is, what vehicle should be used to serve the purpose?
“We would like to set up an ILIT to purchase a life insurance policy. The goal is to maximize cash value and death benefit at the same time. Could you please help us shop around?”
“Unfortunately, cash value and death benefit, you cannot maximize them at the same time. Eventually, you can only choose one.”
“Why? We bought life insurance before, the illustration shows both cash value and death benefit.”
“By gifting money to a trust in the purpose of purchasing a policy, you, being the grantor won’t benefit from the money anymore. Therefore, cash value should be out of concern here.”
“Also, when choosing a life insurance policy for estate planning purpose, we should always prioritize death benefit amount.”
There are many different types of insurance vehicles on the market. Each has its own merits and may be appealing to different audiences. When it is time to choose the right product for estate planning purpose, make sure you consult with a financial professional who is specialized in estate planning.
*All names in the article are fictitious.
* All examples are hypothetical and are not representative of any specific situation.
* The content provided herein is based on our interpretation of "The Tax Cut and Jobs Act" and is not intended to be legal advice or provide a tax opinion. This document is a summary only and not meant to represent all provisions within "The Tax Cut and Jobs Act"