California apartment owners should have cheered the Tax Cut and Jobs Act (“TCJA”) provisions that doubled Estate and Gift Tax Exclusions beginning in 2018. For many apartment owners, these provisions increased the Exclusion to $11.58 million for a single person, and $23.26 million for a married couple in 2020.
Unfortunately, the doubling was only temporary, scheduled to expire at the end of 2025. We call this scheduled expiration the “Sunset”.
Finally, about two years after enactment of the TCJA, the IRS has adopted “permanent” regulations on how these exclusions will work after 2025.
The good news: TO THE EXTENT that you use your doubled exemption in full before 2026, the IRS will not take it back if you die or make gifts after 2025.
But, the bad news (which we expected): If you do not “use it” before 2026, the increased exemption evaporates, unless the House, Senate and President approve an extension.
[We think that, in the current environment, with growing fiscal deficits, the chance of extension is slim. In fact, we think the risk of even further reductions in the Exclusion is greater than the likelihood that the expanded Exclusion will be extended. Worse, while proposals to add a California estate tax have failed recently in the legislature, liberal domination of the legislature makes the addition of a California Estate Tax a real risk.]
Unfortunately, the new regulations make it clear that most partial uses of the increased exemption will not benefit your family after 2025 except to the extent they exceed the (reduced) 2026 exemption.
Who Should Worry About This
Many apartment owners have been lulled into inaction by the current $11.58/23.16 million exclusion to forego planning to use the expanded exclusion. They think that need not worry about estate taxes since they have less than $11.58 million as a single person, or less than $23.16 million as a couple. However, this creates two “HAZARDOUS” traps for family wealth in two ways.
- First, if your net worth continues to grow (as you probably hope it does), it may take you beyond the expanded Exclusion even without Sunset.
- Second, many of you will live beyond 2025. If so, unless you do effective planning before 2026, the Exclusion will be cut in half, exposing your estate to unnecessary Estate, Gift and/or Generation Skipping Taxes
Prudent apartment owners should calculate their risk of Estate Tax exposure with and without Sunset.
Remember, if your estate grows at a compounded rate of 4.5% per annum, it will increase by about 50% in ten years, and double in about 16 years. A woman age 75 has a 50% statistical chance to survive more than ten years, while those with more wealth probably have an even better chance due to lifestyle advantages. We believe that most of our healthy 75 year-old female clients will live long enough to double their estates at a 4.5% growth rate.
Calculating Your Risk
The math to calculate your exposure before and after Sunset, through your life expectancy, can seem daunting.
To simplify this, I have developed a spreadsheet I call the “Estate Tax X(posure)-Ray” to do rough projections of your exposure.
The X-Ray allows for quick “what if” calculations using either my assumptions, or your assumptions, regarding anticipated inflation, growth in net worth and life expectancy to calculate your family’s projected exposure. It can give you an idea of how much in Estate Tax your family can save with timely sound planning. The spreadsheet allows you to project the savings using different sets of assumptions (we can show both conservative and aggressive assumptions if you like).
A Few Examples
- Paul Grasshopper Fails to Use Any of His Exclusion before 2026
Paul Grasshopper, a single man, with a net worth of $10 million, figures he does not need to worry about Estate Taxes, since his net worth is almost $1.6 million below the 2020 Estate Tax Exclusion. So, he makes no reportable gifts before 2026.
If he dies at the end of 2025, his estate will have grown to approximately $12.5 million (assuming his estate grows at 4.5% per annum, compounded), and the projected Exclusion will just barely shelter his estate from the death tax.
But, if he dies on January 1, 2026, after the scheduled Sunset, his exclusion will only be about $6.33 million (all 2026 Exclusions are calculated here with an estimated 1.5% inflation adjustment, roughly equal to the adjustment used for 2020). His heirs will then face unnecessary Estate Taxes (based on current law) of about $3.7 MILLION!
- Paul Uses Part of His Exclusion before 2026
Suppose Paul instead makes his first reportable gift of $3 million in 2020. He will not need to pay any gift tax, but the gift reduces his remaining Exclusion.
At the end of 2025, Paul’s remaining Exclusion projects at about $8.58 million, plus an inflation adjustment that would likely bring it to $9.47 million. Assuming his net worth grew at 4.5% per annum, his net worth would then be about $8.7 million, leaving no Estate Tax exposure in 2025.
But, come January 1, 2026, his remaining exemption will drop to an estimated $3.33 million. If he dies in 2026 instead of 2025, his wealth then faces approximately $2.2 million in completely unnecessary Estate Taxes due to his “Failure to Plan Well” before 2026!
- Paul Grasshopper Uses His Exclusion before 2026
On the other hand, if Paul had done sound planning in 2020, he could have completely eliminated the risk of Estate Taxes, even if rates increase, Exclusions decrease or California adopts its own death taxes.
Sound planning could also have provided Paul all the cash flow he would need over his life expectancy to maintain his lifestyle.
These same principals work for married couples, and even better as they get the benefit of two sets of Exclusions!
The Bottom Line
As onerous as they may seem, Estate (and Gift) Taxes remain purely voluntary in the United States for almost anyone.
Congress has given us the tools to pass enormous wealth free of any Estate, Gift or Generation Skipping Tax.
These tools will work best if implemented before the anticipated Sunset of the doubled Exclusion in 2026, before the Democrats increase rates or decrease exclusion, and before California adopts its own Estate Tax.
So, the bottom line for the moderately successful apartment owners remains consistent with our motto:
“If you fail to plan WELL NOW, plan to FAIL!” But, good planning requires projection of life expectancy and future growth in your net worth. If you want help with that, I can assist you to do projections using my “Estate Tax X(posure)-Ray.”
If it projects a substantial Estate Tax, I can show you strategies that can eliminate such taxes for your family and still provide for your personal well-being during your life.
Kenneth Ziskin, an estate planning attorney, focuses on integrated estate planning for apartment owners to save income, property, gift and estate taxes. He also provides trust and probate administration assistance after the death of a loved one. He holds the coveted AV Preeminent peer reviewed rating for Ethical Standards and Legal Ability from Martindale-Hubbell, a perfect 10 out of 10 rating from legal website AVVO.Com, and is multiple winner of AVVO’s Client Choice Award.
See Ken’s website at www.ZiskinLaw.com. Ken plans to expand on this topic at the AOA Trade Shows in Long Beach and Los Angeles. Ken also offers FREE CONSULTATIONS FOR AOAMEMBERS in appropriate cases. Call him at (818) 988-0949.
This article is general in nature and not intended as advice for clients. Please get advice from counsel you retain for your own planning.