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Look Before You Leap…or GIFT – US Gift Tax Exemption

While the US estate and gift tax exemption currently stands at a hefty $11.7 million (2021), it doesgifting 2021 not mean that you will benefit from it on a gift you make today. Due to President Biden’s historic win, Americans are facing down the barrel at some potentially drastic changes to the tax law. Under proposed changes that Biden’s team has released the estate and gift exclusion would decrease from the current $11.7 million to a greatly reduced $3.5 million. In addition, there will likely be an increase in the estate and gift tax rate from the current 40% to 45%.

The X factor in all of this is the retroactivity of the potential changes outlined above.  Will new law apply from an earlier date (retroactively imposed) or from the date that the law is passed?  If prior behaviour is any indication, then buyer beware.   It is not uncommon for new tax laws to be applied retroactively.  This can have a huge impact on gifts you make now, under the current rules, but which end up being subjected to the new laws yet written, at a later date.

A quick example will show the potential disaster waiting to happen.

Example:

January 1, 2021 you made a gift of $10 million to your brother. Having never previously used any of your gift tax exclusion, the entire amount of the gift is sheltered from US gift tax under the current rules.

November 1, 2021, new tax law legislation is passed. The above-discussed estate and gift tax changes are instituted and made retroactive to the start of 2021.

Now, instead of no gift tax on the $10 million gift to your brother, you find yourself stuck with a $2.9 million gift tax:
$10,000,000 (gift)
– $15,000 (yearly allowed gift amount)
– $3,500,000 (new gift exclusion amount)
$6,4850,000 x 45% (new estate and gift tax rate) = $2,900,000 gift tax (rounded).

So, while we cannot predict what will happen, we can provide a warning so you can understand the risk and plan accordingly. As well, we can perhaps glean a bit of a silver lining in the IRS’s treatment of the changes brought to this same area of tax law back in 2017 with the passing of the Tax Cuts and Jobs Act.  This act increased the estate and gift tax exclusion to its current levels but under this law, the exclusion amount would revert to pre-2017 levels in 2026. Taxpayers were worried that they would be hit with possible taxes and penalties in 2026 for gifts made during this period of increased exclusion. The IRS clarified that this would not be the case; there would be no surprises when the current rules sunset. While not directly on-point, it does give hope that the IRS can be understanding in certain circumstance.

Contact us if you have concerns about your tax planning.

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