Wealthy Americans Rush to Donate Millions Before Tax Breaks Expire Next Year

With the presidential election approaching and no definite winner in sight, many affluent taxpayers are gearing up to safeguard their wealth against possible tax hikes, according to financial experts.

One significant impact could occur if the tax reductions implemented under former President Donald Trump are allowed to expire at the end of 2025. This would particularly affect federal estate and gift tax exemptions.

The Tax Cuts and Jobs Act of 2017 (TCJA) temporarily increased these exemptions significantly. By 2025, the exemption is projected to reach $13.99 million per individual, up from $13.61 million in 2024. Without legislative action, however, these amounts will revert to around $7 million ($5 million adjusted for inflation) post-2025.

The Tax Policy Center predicts that the number of returns subject to estate taxes will nearly triple from just over 7,000 in 2024 to about 19,000 after the exemption thresholds decrease.

While this affects a small fraction of the U.S. population, those impacted are actively planning ahead, specialists note.

What’s the Financial Impact?

Estate taxes can vary from 18% to 40% based on the amount exceeding the exemption thresholds. Taxpayers face a base tax plus a marginal rate on amounts above each tier.

Additionally, some states impose their own estate taxes, though these typically have much lower exemption thresholds and top rates compared to federal taxes.

Should Planning Begin Before Election Results?

“Planning ahead has no drawbacks,” stated Brian Large, a partner at Lenox Advisors. He emphasized the importance of proactive financial planning.

The TCJA represented the most extensive tax code overhaul in three decades, introducing significant tax cuts for both businesses and individuals that are set to expire by the end of 2025. Many financial professionals, including accountants and lawyers, anticipate being in high demand as these changes approach. Effective planning often requires time-consuming legal documentation and substantial financial transactions.

“The upcoming eighteen months will be quite intense for all involved,” remarked Miklos Ringbauer, founder of MiklosCPA. He advises taxpayers to stay ahead of upcoming changes.

How are the Wealthy Utilizing Trusts Before TCJA Ends?

The extremely wealthy are maximizing the increased gift and estate tax exemptions by making significant gifts to heirs or trusts, aiming to reduce their taxable estates and minimize future tax liabilities.

Assets placed in irrevocable trusts are not considered part of your estate, though this means relinquishing control over these assets. The ideal assets for these trusts are those that are likely to appreciate in value, thus transferring both the initial asset and its growth out of the taxable estate.

There are several types of irrevocable trusts, such as:

Grantor-Retained Annuity Trust (GRAT) that allows the grantor to receive a fixed annuity for a specified term. These trusts are often used by older adults desiring stable income and hold assets expected to appreciate, potentially outperforming the IRS’ hurdle rate, thus passing on excess growth tax-free to beneficiaries at the end of the term. In October, the hurdle rate was at a low of 4.4%, with expectations of further decreases.

Karen Fierro, a tax partner at Wiss, suggests setting up short-term, rolling GRATs to take advantage of falling interest rates, thereby maximizing the tax-free transfer of asset growth.

If a GRAT underperforms, it simply dissolves, and the assets revert to the grantor, minimizing risk. If the grantor dies before the term ends, the assets might return to the estate and be subject to taxes.

Spousal Lifetime Access Trust (SLAT) allows a spouse to place assets in an irrevocable trust, effectively removing them from the estate. The beneficiary spouse can access the trust’s assets during their lifetime, with the remainder passing tax-free to other beneficiaries after their death.

What Other Strategies Exist Beyond Trusts?

Intra-family loans are another method for wealth transfer, avoiding the use of the lifetime gift exemption. These loans can be used for purposes such as buying property or funding a business, often under more favorable terms than commercial loans. The IRS sets minimum interest rates for these loans, known as applicable federal rates (AFR).

For instance, a parent might lend $1 million to their child under a 12-year interest-only loan at a 2.25% AFR. If the child invests this amount and achieves a 10% return, the investment would grow significantly, with the excess growth passed to the child tax-free at the end of the loan term.

Gifting non-publicly traded assets can also be advantageous due to potential valuation discounts. These assets, which can be hard to price, may be undervalued in official assessments due to factors like illiquidity or lack of control. Professional appraisal is required, and combining these gifts with trusts can offer additional benefits.

Could the Tax Cuts Be Extended?

It’s possible for the tax cuts to be extended. Former President Trump has expressed intentions to maintain most of his tax cuts, including those on estate taxes. Vice President Kamala Harris has indicated she would increase taxes on the very wealthy, though she hasn’t detailed plans for estate taxes specifically.

The decision ultimately lies with Congress, and predicting its future composition and decisions is challenging, according to experts.