The world of estate and gift taxes can seem complex, especially with evolving tax laws. This FAQ addresses common questions about how recent tax reforms affect gift and estate tax, with a focus on the Gift Tax Lifetime Exemption. For more detailed information, you can always refer to the Estate and Gift Taxes page on the IRS website.
Gift and Estate Taxes: What Are They?
Gift and estate taxes are applied to the transfer of wealth. In simpler terms, they are taxes on significant gifts given during a person’s life and on substantial assets passed down to heirs after death. These taxes are designed to affect only large transfers of money, property, and other valuable assets.
How are Gift and Estate Taxes Calculated?
The calculation for both gift and estate taxes utilizes a unified rate schedule. This means that a single set of tax rates is applied to the total of your taxable gifts given throughout your lifetime and the value of your taxable estate at death. To determine the actual tax owed, a credit is applied, which is based on the applicable exclusion amount.
A crucial part of this exclusion is the basic exclusion amount (BEA). This BEA is subtracted from your combined taxable gifts and estate, reducing or eliminating the tax. This credit is first used against gift tax when gifts are made. If any credit remains after covering gift taxes during your lifetime, it is then applied to your estate tax upon death.
Changes Introduced by Tax Reform
The Tax Cuts and Jobs Act (TCJA) brought significant, though temporary, changes to the gift and estate tax landscape. Most notably, the TCJA doubled the basic exclusion amount (BEA) for the years 2018 through 2025.
Because the BEA is adjusted annually to account for inflation, the amounts have varied slightly each year:
- 2018 BEA: $11.18 million
- 2019 BEA: $11.4 million
- 2020 BEA: $11.58 million
This substantial increase, however, is not permanent. Under the current law, in 2026, the BEA is scheduled to revert back to its pre-2018 level of $5 million, adjusted for inflation since then.
Alt text: A brightly wrapped gift with a stylized tag symbolizing the gift tax lifetime exemption.
IRS Clarification: No Penalty for Utilizing Increased Exemption Now
Concerns arose about the potential implications for individuals who made large gifts between 2018 and 2025, taking advantage of the higher BEA, and what would happen when the exclusion amount decreased in 2026.
To address these concerns, the IRS issued final regulations to clarify the situation. The IRS confirmed that individuals who utilize the increased BEA by making gifts between 2018 and 2025 will not be negatively affected when the BEA is reduced after 2025.
The regulations include a special rule. This rule essentially allows an estate to calculate its estate tax credit using the greater of either:
- The BEA that was in effect when the gifts were initially made (during the 2018-2025 period).
- The BEA in effect on the date of the individual’s death.
This clarification provides significant reassurance. It means that individuals can confidently make substantial gifts between 2018 and 2025 without worrying about losing the tax benefits associated with the higher exclusion level once it is reduced in the future.
Example of the Special Rule
Let’s illustrate how this special rule works with an example:
Imagine person A had never made any taxable gifts before 2018. In 2018, when the BEA was $11.18 million, A makes a taxable gift of $9 million. A uses $9 million of their available BEA to reduce the gift tax on this gift to zero.
Person A then passes away in 2026. Even if the BEA is lower in 2026 than it was in 2018, A’s estate will still be able to calculate its estate tax based on the higher $9 million BEA that was utilized in 2018. This ensures that A’s estate is not penalized for taking advantage of the higher exemption amount when it was available.
Navigating Gift Tax Lifetime Exemption
Understanding the gift tax lifetime exemption and its nuances, especially in light of recent tax reforms, is crucial for effective estate planning. The IRS clarification offers valuable security for those considering making significant gifts. For more comprehensive details on tax reform provisions, please visit IRS.gov/taxreform.
Disclaimer: This FAQ provides general information and should not be considered legal authority. It cannot be used to support a legal argument in court.
