Wolters Kluwer Reviews Changes to Federal and State Estate and Gift Tax Rules
Although 2022 begins without major legislative activity impacting estate and gift taxation, the tax community is still absorbing the changes made by the Tax Cuts and Jobs Act of 2017, the most comprehensive in decades and including a major shift in federal estate and gift taxes.
Updates for 2022 Estate and Gift Taxes
The Tax Cuts and Jobs Act did not repeal the federal estate, gift, and generation-skipping transfer (GST) taxes. Instead, the basic exclusion amount for purposes of the estate and gift tax, and the corresponding exemption amount for purposes of the GST tax, was doubled from $5 million to $10 million before adjustment for inflation. Due to budgetary constraints in drafting the legislation, this change is only temporary and set to expire after 2025, if further legislative intervention does not occur beforehand.
Another major change included in the Tax Cuts and Jobs Act was the methodology used to compute inflation-adjusted amounts throughout the Internal Revenue Code, including those related to estate and gift taxes. This change uses a different measuring device called the Chained Consumer Price Index for All Urban Consumers (C-CPI-U) to gauge inflation. Because the C-CPI-U reflects inflation at a somewhat slower rate than the previous methodology, it was expected that many inflation-adjusted amounts would be lower than if they had been computed under the old method. For example, the lifetime basic exclusion amount for 2018, as computed using C-CPI-U, came to $11.18 million per person and $22.36 million for a married couple, which was somewhat less than the expected figures of $11.2 million per person and $22.4 million available for a married couple. For 2022, the inflation-adjusted amounts are $12.60 million ($11.70 million in 2021) and $24.12 million ($23.40 million in 2021), respectively.
Another important figure indexed for inflation is the annual gift tax exclusion, which increases to $16,000 in 2022, up from $15,000 in 2021. Accordingly, for 2022, tax-free gifts of up to $16,000 per donee will be permitted or $32,000 per couple using gift splitting.
In 2019, the IRS finalized regulations, effective for the estates of decedents dying on or after November 26, 2019, that clarify a potential downside to the increase in the lifetime gift and estate tax exclusion amount. Because of the temporary nature of the increase in the lifetime exclusion amount, practitioners questioned whether a gift that was excluded from tax during the period 2018 to 2025 could effectively be recaptured and the tax on it “clawed back” if the exclusion amount were to decrease in later years to an amount below that of the prior gifts. The final regulations clarify that taxpayers taking advantage of the increased exclusion amount will not be adversely affected after 2025 when the exclusion amount is set to decrease to pre-2018 levels ($5 million, as adjusted for inflation).
Wolters Kluwer notes that this should help to encourage clients, who can afford to do so, to take advantage of the large exclusion amount while it is still in effect. Planning for large gifts to use all of the current large exclusion amount must take into account the inherent uncertainty as to whether and by what amount the exclusion might be reduced, and whether such change would be retroactive, Wolters Kluwer cautions. Any such gifts should be made as soon as possible to ensure that the planning is completed prior to legislative enactment if the effective date is prospective and the planning should be flexible in case the effective date is retroactive to a date prior to enactment. Planners should consider strategies, such as the use of disclaimers, low-interest loans, or spousal lifetime access trusts (SLATs), that would mitigate any retroactive effective date.
State Estate Tax Developments
Although many states have historically based their estate tax laws on the federal estate tax, some states have passed their own “stand-alone” estate tax laws as a way of holding onto tax revenues. They include Connecticut, Hawaii, Maine, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington State. Other states that still retain an estate tax include Illinois, Maryland, and Massachusetts. The District of Columbia also imposes an estate tax. Several other states still have “pick-up taxes” that seemingly would apply, but, because their laws remain geared to the repealed federal credit for state death taxes, no taxes are collected under these laws.
Ten states have no estate tax at all: Arizona, Delaware, Georgia, Indiana, Kansas, New Jersey, North Carolina, Oklahoma, South Dakota and Texas. Other states, such as California and Florida, technically still have a tax on the books, but the taxes are based on the now-repealed federal credit for state death taxes. It is highly doubtful that the federal credit will ever be reinstated. Consequently, those states do not tax the transfer of an estate either.
In addition to estate taxes, six states currently collect an inheritance tax. This is a tax on the portion of an estate received by an individual. It is different from an estate tax, which taxes an entire estate before it is distributed to individual parties. These states are Iowa (phase-out repeal beginning in 2021, until total repeal in 2025)1, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. Assets transferred to a spouse are exempt from inheritance taxes and some states exempt assets transferred to children and close relatives. Connecticut is the only state that imposes a gift tax.
The Tax Cuts and Jobs Act did not change the rate structure for estate and gift tax, which has been in place since passage of the American Taxpayer Relief Act (ATRA) of 2012. Accordingly, the maximum estate tax rate remains 40 percent.
Rules for Surviving Spouses and Portability
Similarly, surviving spouses are still eligible for the benefits offered by “portability” of the estate tax exclusion amount. However, to take advantage of portability, the estate of the first spouse to die must decide whether they want to make the portability election and file a federal estate tax return (Form 706), even if one would not otherwise have been required.
For example, if one spouse died in 2022 after using only $4 million of his or her exclusion for lifetime gifts, the other spouse would still have their $12.06 million exclusion (or a higher amount depending on the inflation adjustment in the year of his or her death) as well as the remaining amount of the deceased spouse’s exclusion, which is not indexed for inflation beyond the year of the spouse's death. The remaining exclusion would also be available to the surviving spouse for gift tax purposes.
Although portability may cause some decedent’s estates to consider filing an estate tax return to make that election, many estate planners believe more traditional strategies may be more effective. Also, the estate tax return (Form 706) is very lengthy, with multiple schedules and involves valuation issues and complex tax laws that can make it very cumbersome and expensive to complete. And, with the large increase in the lifetime exclusion amount, fewer estates would be required to file an estate tax return, notes Wolters Kluwer.
Additional Key Points on Estate Taxes and Portability
- Estates have up to nine months after a person dies to file an estate tax return, but can, and often do, request a six-month extension.
- Estates that fall below the exclusion amount are not required to file Form 706, but they must do so to make the portability election.
- Portability amounts are not indexed for inflation that occurs after death. As a result, a spouse who survives considerably longer than their pre-deceased spouse could see assets appreciated beyond the available estate tax exclusion amount. Accordingly, any amount in excess of that amount could now be subject to tax at 40 percent.
- If a spouse remarries or has additional children, he or she can decide where the property will go, which may not be the same intentions of the decedent spouse.
- Assets are not protected from creditors.
- Despite the addition of portability, at least some estate planners still favor using traditional credit shelter trusts to address these issues. However, establishing and maintaining such trusts can also present certain costs, Wolters Kluwer notes.
Another recent change that estates and beneficiaries should keep in mind is the need to maintain a consistent basis for inherited assets for both estate and income tax purposes. A recipient’s basis in property acquired from a decedent will be the same as the value reported for estate tax purposes.
There are applicable reporting requirements and potential penalties that may be imposed for failure to comply with the basis consistency rules.