Taxpayers making large gifts no longer have to worry about big federal estate taxes coming back to bite them years from now. However, the State of Illinois does take into account large gifts (more than $15,000 per person per year under current laws in 2020) when assessing the Illinois estate tax payable at death on assets in excess of $4,000,000 that pass to children or another non-spouse beneficiary.
The IRS finalized regulations confirming that gifts made under the increased lifetime exemption under the Tax Cuts and Jobs Act of 2017 (TCJA) will not be subject to federal estate tax when the exemption returns to the rates that existed before the law went into effect (slated to occur on January 1, 2026).
The TCJA temporarily increased the federal gift and estate tax exemption from $5 million to $10 million, with both amounts adjusted for inflation, beginning in 2018. The increase is scheduled to sunset at the end of 2025, which means that starting in 2026, the exemption is set to return to the prior amounts unless the law is again updated.
The law left an open question as to whether a gift made using the increased federal estate tax exemption would be taxed at death if the person died after the exemption sunsets.
For example, it was unclear how an estate would be taxed by the United States if a person made a gift of $8 million in 2020 and passed away in 2026, when the federal estate tax exemption amount is set to return to $5 million. Experts wondered if the amount of the gift that was over the exemption at the time of death (in this case, $3 million) would be subject to transfer taxes. This type of taxation is known as a “clawback.” Under the newly finalized regulations, the estate of a deceased taxpayer who made the $8 million gift would not have to pay federal estate taxes on the $3 million. The regulations say that in 2026, such a taxpayer’s basic exclusion amount at death is either 1) the basic exclusion amount applicable to gifts made during life when the exclusion amount was increased, or 2) the basic exclusion amount available to the taxpayer at death, whichever is greater. For additional information: https://www.irs.gov/newsroom/estate-and-gift-tax-faqs
The Sensible Taxation and Equity Promotion (STEP) Act would get rid of what’s known as the step-up in basis to tax the unrealized gains of certain estates at death.
Step-up in basis refers to the way the value of an asset is readjusted for tax purposes upon inheritance.
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