Recent developments in the world of estate planning have created new opportunities for clients to make gifts to their family members and to engage in other tax planning strategies. 

Increase in Gift Tax Exemption

Currently, each individual has a $12,060,000 lifetime unified gift and estate tax exemption.  The IRS recently announced that the gift and estate tax exemption will be increased to $12,920,000 for 2023.  That means each person has $860,000 more exemption. 

For those who have previously used their entire exemption, this increased exemption amount creates additional gifting opportunities for cash gifts, gifts of closely-held businesses or real estate interests where the value at first may seem to exceed $860,000 but where discounts may be obtained to lower the value, and where leveraging opportunities exist. 

For example, for someone who previously fully used their exemption, a gift of $800,000 of assets to a “grantor” trust can be followed by a tax-free sale of $7,000,000 of assets to that trust, and the asset appreciation that grows over time can be retained in the trust free of gift and estate tax.  For someone who has not previously made gifts, they can transfer even more assets into a trust to use the increased exemption.

An additional motivation to make gifts now is that, notwithstanding the current high exemption amount, under current law the gift and estate tax exemption is set to dramatically decrease in 2026, which based on inflation adjustments, is estimated to be around $6,000,000-6,500,000 at that time.  Therefore, making gifts now could utilize approximately $7,000,000 of exemption that is set to disappear in 2026, absent Congressional action.

For smaller gifts, the annual exclusion for gifts increases to $17,000 for 2023.

Higher Interest Rates

For over 10 years with low interest rates, several estate planning techniques (such as “GRATs”) have been effective tools to shift assets to family members with a low “hurdle” rate or bar to clear to achieve the planning goals of transferring assets with minimal tax and exemption used.  Now, with interest rates climbing, such planning may still be viable but returns on investments will need to be higher for the gifting objectives to be accomplished.

At the same time, a higher interest rate environment means that certain planning strategies that have been mostly dormant or underutilized for years are useful once again.  These strategies are more attractive because higher interest rates can decrease the value of remainder interests (thus reducing the size of a gift) or future taxable cash flows from transferred assets.  Here are two examples.

Qualified Personal Residence Trust – With a “QPRT”, a person can transfer a residence to a trust for the future benefit of family members, retain use of the property for a certain period of time (e.g., 20 years), and at the end of the trust term either vacate the property or continue to reside there while leasing the property.  The amount of gift tax incurred in connection with the transfer of ownership is based only on the value of the remainder interest transferred to the trust which is determined from the residence’s current value.  With higher interest rates, the transferred value becomes smaller.  Any appreciation in the value of the residence after the transfer to the trust should not be subject to gift or estate tax. 

A QPRT can own a primary residence or, in certain situations, a vacation home. 

As an example, if a house valued at $5,000,000 is transferred to a QPRT today, that transfer would use approximately $1,950,000 of gift tax exemption; if the same house had been transferred last November when interest rates were lower, the gift would be valued at approximately $3,800,000.  As you can see, the current level of interest rates makes this type of planning for a family residence much more attractive.

Charitable Remainder Trust – A “CRT” combines income tax benefits with charitable giving that can satisfy a client’s charitable intentions.

With a CRT, a client transfers assets to the trust free of gift tax and with a Charitable Remainder Unitrust, a percentage of the value of the assets is distributed at least annually to a noncharitable beneficiary (e.g., the client/donor).  At the end of the trust term, the remainder passes to a charity. 

For the donor, a current income tax deduction is available for the present value of the remainder interest that will go to charity, while the donor retains an income stream that is subject to income tax.  However, the CRT is a tax-exempt entity, which means if the assets transferred to the trust are sold then the gain is not taxed to the donor all at once but is allocated to the donor over time as distributions are received.  This is a useful tax deferral mechanism for an appreciated asset that will be sold.

A CRT makes sense when interest rates are rising because the value of the future taxable income stream it creates is reduced (which is useful if the donor receives that income stream or it is gifted away) and the size of the charitable gift is increased.