The Tax Cuts and Jobs Act (TCJA) took effect on Jan. 1, 2018, and impacted personal income taxes, small businesses, estate tax rules, capital gains rules, special needs accounts, and much more. The TCJA is scheduled to sunset at the end of 2025. This will lead to significant changes for taxpayers. So, are there ways to avoid potential tax impacts to you or your loved ones? Read on to learn more.
Gift Now and Get the Benefit of the Current Gift Exclusion
One of the most discussed effects of the TCJA sunsetting is the slashing of the federal estate and gift tax exclusion to pre-2018 levels, as adjusted for inflation. The current exemption is $13,610,000 per individual. Starting in 2026, it will go down to the 2017 exemption of $5,490,000 per individual (as adjusted for inflation). This drop is potentially a big hit for the heirs of anyone who passes away after Jan 1, 2026.
The estate and gift tax exclusion is essentially a credit applied to gifts made by a person while they are alive or a person’s total taxable estate upon their death to minimize how much will be subject to federal tax. So, for example, under current rules, if a person has a total taxable estate of $8 million and made $1 million of gifts in their lifetime, their estate can apply a $9 million exclusion or “credit,” and not owe taxes. However, if this person passes away in 2026, their estate will likely suffer tax consequences as there would not be a credit sufficient to cover an $8 million taxable estate (if the gifts were made before 2026, they may be covered, as explained below).
It is possible to mitigate this potential scenario in several ways. One of them is making large gifts before December 31, 2025, while the gift tax exclusion amount in effect is at record highs. The IRS has stated that this practice won’t harm estates after 2025. Specifically, IRS regulations have a special rule that allows an estate to take an estate tax credit using the greater of the exclusion applicable to gifts made during life, or the exclusion in effect on the date of death. The result is that if gifting makes sense in your situation, you can make large gifts up to the exclusion limits until 2025 without worrying that the temporarily higher tax benefits will be lost if you pass away after 2025.
And don’t forget that a person can gift up to $18,000 per year (or $36,000 per year for couples who file jointly) to as many people as they wish. These gifts don’t count toward their lifetime exclusion. So, for a couple with three children and six grandchildren, they can gift these individuals $162,000 per year without touching their exclusion. This can be an easy way to transfer wealth to the next generation tax-free.
Maximize Gifts to 529 Plans
Another option to get ahead of the TCJA ending is to contribute the maximum amount of money to 529 plans set up for children and grandchildren (and other selected categories of people). Current law allows up to five years of annual gifts to a 529 plan in one shot. And, starting in 2024, distributions from 529 accounts will no longer be counted as income to the student when applying for federal student aid.
So, if you want to give funds to loved ones but have concerns about how it may be spent, you can deposit $18,000 ($36,000 for a couple) into a 529 account for their benefit. Current rules also allow you to make an accelerated gift of up to five years’ worth of gifts to a 529 account in one year and spread out the gift tax liability over five years. If you gift less than the annual gift tax-free amount, there is no tax liability.
The result is that a couple could gift $170,000 now to a 529 account. They would, however, need to file a gift tax return and elect the five-year treatment. One caveat to this option is that the gift giver must survive beyond the five-year period for the gifts to be fully excluded from their taxable estate. To ensure this is done correctly, it is essential to consult with a qualified tax professional. However, if done properly, it is an effective way to reduce a person’s taxable estate.
Consider an Irrevocable Life Insurance Trust
Another potential way to leave money to loved ones and not increase your taxable estate above the impending lowered exclusion amount is to purchase a policy owned by an irrevocable life insurance trust. The benefit paid to your beneficiaries is also potentially tax-free income for them. This planning technique should not be undertaken without the counsel of an attorney, as it may have other implications for your personal situation.
Max Out ABLE Account Contributions
An ABLE account is a savings program run by the state for certain individuals with disabilities. Beneficiaries may use ABLE account funds to pay for qualified expenses tax-free. ABLE accounts are also disregarded as assets when determining if a person qualifies for Supplemental Security Income (SSI) and certain other means-tested federal benefits. If your loved one qualifies for an ABLE account, you may be able to improve their quality of life while reducing your future taxable estate. You can contribute up to the annual gift tax exclusion amount.
Furthermore, the TCJA allows an employed beneficiary who does not participate in an employer-sponsored retirement plan to contribute up to 100 percent of their earned income to their ABLE account up to the prior year’s poverty line amount for a one-person household ($14,580 as of 2024).
So, ABLE accounts can be built up quickly where a parent makes a gift contribution and the disabled child also contributes their earned income. The child, if over 18, may also be able to claim the Saver’s Credit on their tax return for up to $2,000 of contributions they made to their ABLE account. But, as with other TCJA provisions, these benefits will end on December 31, 2025.
Not all these options may be appropriate for everyone, and it is always prudent to make any financial planning decisions with the advice and counsel of a professional. However, the sooner you act, the more options you may have before the TCJA sunsets. The Elder Law attorneys at Mandelbaum Barrett PC are available to answer any questions you may have.