How Annual Exclusion Gifts Can Be a Deceptively Powerful Estate Planning Strategy

In 2022, it may be tempting to dismiss planning for gift and estate taxes as unnecessary because of the $12.06 million federal gift and estate tax exemption. But even if your net worth is only a fraction of this lifetime exemption amount, there are good reasons to adopt strategies — such as making annual exclusion gifts or even larger gifts against the exemption — to reduce the size of your taxable estate.

The annual exclusion allows you to make yearly tax-free gifts up to $16,000 (in 2022) per person to any number of recipients. If you’re married, you and your spouse can give up to $32,000 per recipient tax-free. And you can make these gifts without using up any of your lifetime exemption amount.

Why make annual gifts?

If there’s little chance that your estate’s worth will even approach the lifetime exemption amount, is there any advantage to making tax-free annual exclusion gifts? The answer, for many people, is yes.

The most important reason for annual gifting is to protect yourself against the possibility that the exemption amount will be drastically reduced in the near future, potentially exposing a portion of your wealth to gift and estate taxes overnight. A “sunset” provision in the Tax Cuts and Jobs Act of 2017, which doubled the exemption amount to its current level, calls for it to return to its previous level in 2026. Without action by lawmakers, the exemption will drop to an inflation-adjusted $5 million after 2025.

A program of annual exclusion gifts offers nontax benefits as well. These include the chance to watch your loved ones enjoy sharing your wealth and the opportunity to help shape your heirs’ behavior (by conditioning gifts on staying in school, for example).

Should you consider larger gifts?

The currently high lifetime exemption amount creates a window of opportunity for families to transfer significant amounts of wealth tax-free. So, if you’re willing and able to do so, it may be advantageous to make gifts now from your excess wealth before that window closes.

Keep in mind, however, that if you own assets that have appreciated significantly in value, or that you expect to appreciate in the future, gifting them to your heirs may have income tax consequences. Assets transferred by gift retain the donor’s tax basis, which means their heirs would be burdened with a larger income tax bill when selling the appreciated assets. Assets transferred at death, however, receive a “stepped-up basis” under current law equal to their date-of-death market value, eliminating any taxable gain as of that date.

Even if you’re not inclined make larger gifts now under your lifetime exemption, consider implementing a program of making regular annual exclusion gifts which will still allow you to transfer substantial amounts of wealth tax-free over time to loved ones.

To explore gifting strategies within the context of your estate plan, please contact your Anchin Relationship Partner.