Prepare Now for the 2026 Cliff, a.k.a. Tax Armageddon

Shrewd people are taking time now to consider the actions they should take in the rest of 2024 and 2025 to avoid falling off the tax cliff.

The 2026 Cliff, or Tax Armageddon as some prefer, is the scheduled reduction of the current lifetime estate and gift tax exemption.

The exemption was doubled in 2017’s Tax Cuts and Jobs Act, but only for 10 years. Under current law, the exemption will be slashed in half after December 31, 2025.

Leaders in Congress will try to find a compromise, but many provisions of the 2017 tax law are set to expire on the same date. Preserving the current exemption amount might be a low priority compared to extending other expiring provisions.

We’ll have a better idea of the range of likely outcomes after the 2024 elections. Why put time into planning now?

Congress is prone to wait until the last minute to strike deals. If you wait until we know the final law, there might not be time to develop and execute a good plan.

There are many factors and options to consider. You should avoid making rushed decisions at the last minute.

Also, people who wait are likely to find that the better estate planners are fully booked by forward-looking clients.

The first step is to run the numbers or have your estate planner do so.

Estimate the value of your gross estate today. Then, project its likely growth over the next five and 10 years and perhaps beyond.

Calculate what the estate tax would be under different scenarios. What if the exemption is cut in half from today’s $13.61 million per person or $27.22 million for a married couple? What if the exemption is reduced further to $5 million per person? What if the maximum estate tax rate is increased from the current 40%?

When your estate might be taxable under some scenarios, consider tax-reduction techniques.

Estate taxes are reduced by decreasing the value of the estate. The simplest strategy is simply to give away money or assets.

But you should consider more than taxes when developing your plan.

First, you don’t want to give away so much that you risk running out of assets during your lifetime.

Also, consider how you’d feel if you gave up control of substantial wealth only to see Congress agree to maintain the current exemption amount or even increase it.

Consider all the tools available for reducing estate taxes. Work through the advantages and disadvantages of each with your planner. You’ll probably decide a combination of strategies, implemented at different times, is the best approach.

A good idea is to have the paperwork for certain strategies prepared and ready to go so that, if necessary, they can be executed quickly in late 2025.

These are the key strategies to consider.

Large gifts. As I said, the easiest way to reduce a taxable estate is to give assets away.

You can make direct gifts of money or property to individuals. Or the assets can be put in an irrevocable trust for the benefit of loved ones. You can give cash or property.

For a gift to be effective for tax purposes, it must be a complete gift. You can’t reserve the right to change your mind and take the property back if the lifetime exemption doesn’t change.

Don’t give away so much money that your lifestyle will be diminished or you’ll worry more about market fluctuations.

There’s a key point to consider before making estate planning gifts.

When you give appreciated property, whether directly or through a trust, the recipient takes the same tax basis in the property that you had.

The recipient eventually will pay capital gains taxes on the appreciation that occurred during your ownership, no matter when that person sells the property. Also, the net investment income tax, discussed in our August 2024 issue, might increase the taxes on a sale.

On the other hand, if you held the property for life, under current law the basis would be increased to the fair market value on the date of your death. No one would pay capital gains taxes on the appreciation during your holding period.

The real tax savings from giving appreciated property is the difference between the estate taxes if you held the property for life and the capital gains taxes a recipient would pay. If the lifetime exemption isn’t reduced, giving appreciated property could increase the family’s total tax bill.

Determine if the potential net tax savings are worth giving up control of the property now.

There’s more about the different ways to make gifts and how to choose the property to give in the October 2022 issue of Retirement Watch, available in the Archive on the members’ section of the website. Also, review the different ways to make tax-free gifts in the March 2023 issue.

You might need to file a gift tax return, which is discussed in the October 2023 issue.

Use gift splitting. Married spouses each have a separate lifetime estate and gift tax exemption and a separate annual gift tax exclusion.

They also can elect to make split gifts on assets they own jointly. That means they give the property jointly and each spouse’s exempt amount is used on his or her share of the gift. They can give away tax-free twice as much as they could if only one person owned the property.

Spouses can make unlimited tax-free gifts to each other without using any portion of the lifetime exemption. So, when one spouse owns a valuable asset, it might pay to first make a gift of half the property to the other spouse and afterward make a split gift to someone else.

Give “discounted assets.” Some strategies allow gifts of assets to be valued at less than their current fair market value, reducing gift taxes or allowing you to give more assets without exceeding the lifetime exemption amount.

Several factors can cause a discount in value.

Lack of marketability often reduces the value of ownership interests in privately held businesses, because they are harder to sell than shares of a publicly traded business. The smaller the business, the harder it is to find a buyer.

A lack of marketability discount also can be applied when there are restrictions on the ability to sell an ownership interest.

There might be a discount for lack of control or minority ownership. A business or property is less valuable when someone owns less than 51% because key decisions are outside the person’s control. Minority discounts frequently can be taken by giving each child in a family a share of the business or real estate.

A gift of future interest in an asset also qualifies for a discount. For example, you might retain the right to live in your home for the rest of your life but give an adult child the remainder interest, meaning the child receives full title after you pass away.

The family limited partnership is a widely used strategy for making gifts of assets at discounted prices. Details are in our May 2024 issue.

There are different ways to structure business ownership to qualify for one or more discounts. The best method depends on the type of business and family details.

The IRS doesn’t like valuation discounts. It’s important to work with a skilled estate planner to find the discount strategy that’s best for you and ensure it is properly implemented.

Keeping control of assets. The spousal lifetime access trust (SLAT) might allow you to remove assets from your taxable estate while continuing to benefit from them. There are pros and cons to SLATs, which are discussed in our August 2024 issue.

Installment sales and more. There are sophisticated strategies that provide benefits in the right cases and should be used only with the guidance of an estate planning attorney.

You can make an installment sale of appreciated assets to your children in 2024. Then, in 2025, if it looks like the lifetime exemption will be reduced, you forgive the debt, giving the children full ownership of the assets and using part of your lifetime exemption before it is reduced. If the lifetime exemption isn’t reduced, the children might default on the installment note and return ownership of the property to you.

Another strategy is to give powers of appointment over the inheritance of property to some family members. Defective grantor trusts as well as trusts that can change their tax status under certain circumstances also can be considered.

Again, don’t try to execute these strategies on your own.