Currently, the gift and estate tax exemption for individuals is $13.99 million (a combined $27.98 million for married couples). However, this lofty exemption amount, created by the Tax Cuts and Jobs Act (TCJA), was not designed to be permanent. The TCJA called for the provision to “sunset” at the end of 2025. Unless Congress extends it, on January 1, 2026, the exemption will be cut roughly in half to approximately $7 million for each individual (adjusted for inflation). In addition, the gift and estate tax rate above the exemption will increase from 40% to 45%.

If the law sunsets as scheduled, it will have significant tax implications for many high-net-worth families. Fortunately, there are strategies you can use to lock in this year’s exemption amount.

What the “sunset” could mean

What are the potential consequences of the gift and estate tax changes? Suppose, for example, that you have an estate worth $10 million at the end of 2025. Assuming the exemption drops to $7 million on January 1, 2026, your potential estate tax will have gone from zero to $1.35 million overnight [($10 million – $7 million) x 45%].

To prevent this from happening, you might use your current exemption to give away some of your wealth to loved ones, either outright or through an irrevocable trust. Once you make this gift, the assets are removed from your estate. Your recipients or beneficiaries enjoy all future appreciation in value free of gift or estate taxes.

Of course, you may not be ready to part with your assets just yet. In that case, there are tools you can use to take advantage of the current exemption amount while retaining some control over your wealth. Let’s look at a few.

Related Read: Expiring TCJA Provisions Could Significantly Alter the Federal Income Tax Landscape for Business Entities After 2025

Spousal Lifetime Access Trusts (SLATs)

For married couples, a SLAT makes it possible to remove wealth from your estate using the current exemption while effectively retaining access to it. A SLAT is an irrevocable trust you establish for the benefit of your spouse (or your spouse and your children or other heirs). Typically, the trust permits the trustee to make distributions to your spouse if needed, which benefits you indirectly. As long as you do not act as trustee, and the trust is designed, funded and operated properly, the assets will be excluded from both your estate and your spouse’s estate. Your spouse will have access to the trust funds should a need arise.

The downside of a SLAT is that your benefits depend on maintaining indirect access to the trust assets through your spouse. If you divorce or your spouse dies, those benefits will be lost. One way to mitigate the risk of death is for you and your spouse to each create a SLAT for the other’s benefit. This allows each of you to use your exemption while retaining access to one of the trusts as beneficiary.

These arrangements must be designed carefully to avoid violating the “reciprocal trust doctrine.” Under that doctrine, the IRS can undo mutual SLATs if their terms are substantially identical.

FLPs and FLLCs

If you own a family business, you might want to structure it as a family limited partnership (FLP) or family limited liability company (FLLC). This would allow you to take advantage of the current exemption amount by giving away significant ownership interests to loved ones without immediately losing control of the company.

Suppose, for example, that you plan to leave the family business to your two children. In a typical arrangement, you would form an FLP to own the business and transfer a 49% limited partnership interest to each child, usually at a discounted value for gift tax purposes. You would retain a 2% managing partner interest, allowing you to maintain control over management decisions. Similar results can be achieved with an FLLC.

Structuring a business as an FLP or FLLC so that it does not come under IRS scrutiny can be challenging. That is why it is important to work with experienced advisors if you choose one of these options.

Act now

There are other potential strategies you may be able to use to lock in the current exemption amount. Examples include qualified personal residence trusts (QPRTs), special power of appointment trusts (SPATs) and domestic asset protection trusts (DAPTs). If you’re interested in taking advantage of one of these strategies, you will need to implement it soon. Once the clock strikes midnight on December 31, 2025, the opportunity may be gone.

Sidebar: Don’t overlook income taxes

As you explore strategies for making the most of the current gift and estate tax exemption, be sure to consider potential income tax implications. Inherited assets generally are entitled to a “stepped-up basis.” This means that the assets’ tax basis is stepped up to their date-of-death fair market value, allowing your beneficiaries to sell appreciated assets without triggering a substantial capital gains tax liability.

Gifted assets, on the other hand, are not entitled to a stepped-up basis. So, as you consider making substantial lifetime gifts, weigh potential gift and estate tax savings against potential income tax costs.

For more information, contact Azuwa Omietimi at 312.670.7444 or [email protected]. Visit ORBA.com to learn more about our Wealth Management Services. Sign up here to receive our blogs, newsletters and Client Alerts.