USE IT OR LOSE IT – The Importance of Planning Now to Make Use of the Federal Exemption From Gift and Estate Taxes

Estate and Succession Planning and Administration

This First Alert highlights the need for near-term planning – “use it or lose it” – if you are to make effective use of your federal exemption from gift and estate taxes.¹

Setting the Stage

The federal exemption from gift and estate taxes represents the amount an individual can give away during his or her lifetime or at death without the imposition of gift or estate taxes.² The exemption is at an all-time high – $11.58 million per person/$23.16 million per couple with an annual inflationary adjustment.

Large, yes – and also temporary. Under current law the exemption is scheduled to revert to $5 million (plus inflationary adjustments since 2012) on January 1, 2026. With significant uncertainty regarding the outcomes of the upcoming presidential and congressional elections, coupled with the pressure on Congress to find ways to pay for the pandemic stimulus package, many believe that there is a strong possibility of a sizable reduction (possibly to $5 million or less) as early as 2021. 

Understanding “Use It or Lose It” – An Example

To make effective use of the current high exemption, it is necessary to give away more than the amount of the exemption which will remain after any reduction. For instance, if you give away $5 million of your $11.58 exemption now, and the exemption drops to $5 million in 2026 (or earlier), you will have used $5 million of your exemption. You will have no remaining exemption available for future planning other than the annual inflationary adjustments. So $6.58 million of your exemption (calculated using 2020 amounts) will no longer be available and will be “lost.” To use it, you would need to part with more than $5 million (or whatever the size of the reduced exemption turns out to be) before the reduction takes effect.

Factors to Consider When Planning to Use Exemption

When determining how much of your exemption to use, you will want to consider, first and foremost, how much you need to maintain your lifestyle and to provide for contingencies such as significant market downturns or extraordinary healthcare expenses.

Specific Planning Options

There are many options for making use of your exemption, which would be tailored to your specific circumstances. If ongoing access to assets is not important to you, your gift may be made outright or in trust. For gifts in trust, the type of trust and its provisions will depend upon your goals for your family, the nature of your assets (for instance, whether you have closely held business interests), and the amount of exemption you have remaining, among other factors.

If the retention of access to the assets is important to you, favored options are the Spousal Limited Access Trust (SLAT), or a self-settled trust (known in Ohio as the Ohio Legacy Trust and more generally as a Domestic Asset Protection Trust or DAPT). 

These and other options for making effective use of your exemption will be discussed in future First Alerts.

What Else Might Be Lost

Significant reduction in the federal exemption is but a part of the challenge we are facing. Under various proposals, the most effective tools for transferring assets and preserving family wealth may be on the block by 2021.³

Do It Now!

It should be apparent that we are at a key moment in the history of planning for family wealth preservation. The critical message: Even though the election is not until November, the time to start planning is now. Effective planning and implementation of that planning takes time. Wait and you risk losing a significant window of opportunity.

Our team of experienced planners can help you navigate the analysis and implementation of an appropriate planning strategy.

¹ The related Federal exemption from the generation-skipping transfer tax, also under attack, is not discussed here.

² The exemption does not limit the amount that can be given to a spouse.

³ A non-exhaustive list of proposed changes that may be effective by 2021 include significant increases in transfer tax rates, loss of the income tax step up in basis for assets owned at death, significant curtailment of the ability to make “annual exclusion” gifts, reduction or elimination of valuation discounts for transferred assets, significant limits on the planning benefits associated with the use of grantor trusts, and shortening the maximum possible duration of family “dynasty” trusts.

For additional information on this topic, please contact your regular Calfee attorney or one the Estate and Succession Planning and Administration attorneys listed below.


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