As part of the Tax Cut and Jobs Act (TCJA), the gift and estate tax exemption doubled from tax years 2018 to 2025. The current exemption for 2024 is $13.61 million for individuals and $27.22 million for married couples. This exemption amount will increase one last time to adjust for inflation for tax year 2025, which is predicted to be $13.99 million for individuals and $27.98 million for married couples. However, this increased exemption is sunsetting at the end of 2025, absent any legislative action prior to the end of 2025. The sunset will reduce the estate and gift tax exemption amounts back to the pre-TCJA amount (indexed for inflation). The current forecasts hold that the exemptions will be approximately $7 million per person as of Jan. 1, 2026.
Despite the upcoming TCJA sunset, the IRS issued regulations clarifying that an individual or estate will not be taxed on tax-free gifts that were completed before 2026 (the “Anti-Clawback Rule”). Under this Anti-Clawback Rule, a decedent’s exemption will be the greater of (i) what gifted before the TCJA sunset (prior to the sunset, approximately $13.99 million per person can be gifted tax free) or (ii) the current amount (which is estimated to be $7 million per person). Thus, many estate planning opportunities must be considered before the end of 2025 in order to utilize the increased exemption since the highest federal estate tax rate is 40% plus state estate taxes, where applicable (for example, Washington, Oregon, Hawaii and Minnesota impose state estate tax).
However, given the heightened scrutiny of the IRS—as illustrated in recent case law and the IRS hiring 1,800 more agents in 2024 that focus on high-net-worth individuals and large businesses—taxpayers (especially high-net-worth families with closely held businesses) should be cautious and strategic with gift and estate planning as we near the end of 2025.
Recent regulations and case law highlights include:
-Transfers to Family Limited Partnership (FLP): On Sept. 26, 2024, the U.S. Tax Court held that the fair market value (FMV) of a decedent’s assets were includable in a decedent’s estate after the assets were transferred to a FLP by the decedent’s power of attorney only a month prior to death. In Estate of Fields v. Commissioner, the decedent’s power of attorney transferred approximately $17 million worth of assets to a FLP in exchange for a 99.9941% interest in the FLP. Approximately one month after the transfer, the decedent died. On the decedent’s estate tax return, the power of attorney, as the executor, hired an appraiser to value the decedent’s interest in the FLP. The appraiser valued the partnership at $10.8 million after applying a 15% discount for lack of control and a 25% discount for lack of marketability. Under IRC Section 2036(a), the date-of-death FMV of transferred assets are included in a decedent’s estate if the decedent retains a significant interest or right in the assets and the transfer is not a bona fide sale for adequate and full consideration (i.e., the transfer is not significantly motivated by non-tax purposes). The Court held that the transfer was not a bona fide sale for adequate and full consideration and as such, the transferred assets were included in the decedent’s estate for valuation purposes.
-Succession Plans for Closely Held Businesses: On June 6, 2024, the U.S. Supreme Court considered whether life-insurance proceeds earmarked to redeem a decedent’s shares of a closely held corporation must be included in the corporation’s valuation for purposes of federal estate tax. In Connelly v. Commissioner, the decedent and his brother were the sole shareholders of a corporation. As part of their succession planning, the brothers entered into an agreement wherein the surviving brother had the option to purchase the deceased brother’s shares, but if the surviving brother declined to exercise the option, then the corporation would be required to purchase the deceased brother’s shares. To ensure the corporation had enough funds to purchase the deceased brother’s shares, the corporation took out a $3.5 million life insurance policy on each brother. The Court held that the earmarked life insurance proceeds were an asset of the corporation, and as such, increased the FMV of the corporation when valuing the decedent’s share of the corporation for federal estate tax purposes.
-Consistent Basis Reporting: Estate executors and beneficiaries often have conflicting viewpoints and motivations regarding the valuation of estate assets for federal estate tax purposes. Executors are motivated to value estate assets at the lowest valuation amount to minimize the value of the estate and the estate tax burden. However, beneficiaries typically want the highest valuation to receive a higher stepped-up basis and minimize gain on the future sales of the assets. This often leads to inconsistent basis reporting (which was previously allowed). On Sept. 17, 2024, the IRS finalized regulations that require consistent basis reporting between executors and beneficiaries. Now, a beneficiary’s initial basis in property may not exceed the property’s final value for estate tax purposes. (Regulation Section 1.1014) To ensure consistent reporting, executors will be required to file Form 8971 and must provide copies of its Schedule A to each beneficiary.
Given heightened IRS scrutiny and the difficulty of obtaining appraisals and proper documentation, taxpayers should consult their wealth advisors for the best and proper utilization of the increased exemption amount before it sunsets under current law on Jan. 1, 2026.
