The 2026 Sunset: How the TCJA Expiration Could Impact Your Estate and What to Do Now
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The 2017 Tax Cuts and Jobs Act (TCJA) effectively doubled the federal lifetime gift and estate tax exemptions from $5 million to $10 million, with adjustments for inflation from year to year. And while the federal exemption will increase in 2025 due to inflation, the provisions of the TCJA, which expanded the exemption amounts, are scheduled to expire, or “sunset”, as of January 1, 2026. Effectively, on that date, the federal exemption amounts will be cut in half automatically unless Congress acts to extend the provisions that created the expanded exemption amounts.
With federal estate taxes currently assessed at a rate of 40%, this means that a taxable estate for a decedent who dies on January 1, 2026, could pay an estimated $2.8 million more in federal estate taxes than if the decedent died on December 31, 2025. Luckily, there are ways to preserve the expanded federal exemption amount by making lifetime gifts, outright or in trust, for your family, prior to January 1, 2026.
Brief History
Historically, there have been a number of significant shifts in the federal gift and estate tax laws, often in connection with other significant overhauls of the Tax Code and/or social reforms. However, since 1976, when the estate and gift tax system was overhauled and the unified lifetime credit was created, the amount of wealth transferred by reason of lifetime gifts or death that is effectively exempt from gift and estate taxes has increased, year to year.
In 2001 and 2003, the Bush-era tax cuts lead to a few interesting scenarios. In 2010, the estate tax was briefly eliminated, though legislation was passed to make it possible for estates to “opt-in” for estate taxes in exchange for those assets receiving a “step-up” in basis as of the date-of-death values, and extending estate tax provisions relating to the lifetime exemption amount for two years. This led to the 2012 “fiscal cliff” and the sunset of the Bush-era tax laws, resulting in the lifetime exemption amount being reduced from $5.12 million in 2012 to $1 million in 2013. However, Congress acted in early January 2013 to pass the “American Taxpayer Relief Act of 2012,” which made the $5 million exemption amount (adjusted annually for inflation) permanent.
With that recent history in mind, many clients are waiting for the results of the November 2024 elections to see whether the political landscape will lend itself to similar legislation that preserves the Trump-era tax cuts, including the expanded lifetime exemption amount. Assuming, however, that the 2025 sunset occurs, the effective change in estate tax liability could be substantial.
Illustration
For example, assume that an individual client with a taxable estate creates a trust this year for the benefit of his or her children and transfers assets worth $13.5 million to that trust before the end of 2025. If the client dies after the 2026 sunset at a time when the federal estate tax exemption is $8.5 million, the client’s estate will not be responsible for estate taxes on the $5 million difference between the exemption used for the 2024 gifts and the applicable exemption at the time of the client’s death. This means that the estate will have avoided at least $2 million in federal estate taxes due to the gift. In fact, assuming that the assets appreciate in the trust over the years since the gift, the estate will have avoided even more in the estate taxes which would otherwise have been assessed on that appreciation because the trust assets are excluded from the taxable estate. Further, when planning for married couples, these savings can effectively double with elections to split gifts.
While the potential estate savings are significant, it is important that we take our time with this kind of planning – to navigate and balance the client’s specific needs and circumstances with the tax savings and other financial considerations.
Considerations
When a family’s net worth far exceeds current exemption amounts, financial advisors and estate planning attorneys will inevitably advise clients to utilize their lifetime exemptions through gifting on a systematic basis because of the potential estate savings. Similarly, where clients are residents of states like Maryland, with its own state estate taxes based on an exemption amount that is less than the federal, advisors may recommend gifting to minimize or eliminate the state estate taxes. However, for many families, maximizing one’s lifetime gifts is a more complex decision-making process, requiring that clients and their advisors (financial and tax advisors as well as estate planning attorneys) consider several factors:
1. Irrevocability & Loss of Control
To effectively remove assets from the taxable estate, gifts should be irrevocable and will necessitate at least some loss of control over the assets. In particular, the client can have no independent control over reacquiring the assets that are transferred. When gifts are made to trusts, the terms are established at the execution of the agreement, meaning that the client cannot change its provisions in the future, so it is important to ensure that the provisions accurately reflect the client’s intentions. If any revisions are made in the future, care should be taken to ensure that the donor does not exercise any control over the process of making revisions.
2. Selecting Assets
An important lesson gained from the 2012 fiscal cliff and the surge of dynasty trusts created in anticipation thereof is that clients should be careful when selecting assets to gift, especially to irrevocable trusts, to ensure that they are comfortable with the following:
- Unrealized Gains or Losses – Gifted assets generally carry the donor’s basis, meaning that appreciated assets, when sold, can generate significant income tax liabilities. However, assets with built-in losses (where the donor’s basis is greater than the fair market value as of the date of the gift) will often have an adjusted basis on any future sale to limit the losses that can be realized by the recipient. When assets are gifted to a trust that is not included in a person’s taxable estate – the client or any beneficiary – there is no adjustment to basis until or unless assets are distributed outright to a beneficiary, meaning that unrealized gains and losses can continue to grow over the years or decades that the trust holds the assets.
- Cash-Flow Needs – Clients should be certain to retain sufficient cash and cash-generating assets to meet their ongoing needs and long-term goals – for personal expenses, income taxes generated by grantor trusts, and gifts that would otherwise be excluded from taxable gifts.
- Special Concerns for Closely Held Business Interests – Many times, closely held business interests are considered for gifting because of the assorted valuation discounts that may apply to interests gifted to individuals or trusts. However, where complex assets are gifted (like business interests), more care and attention are needed – including a careful review of the governing instruments (potentially with input and advice from corporate counsel) to determine whether updates to agreements are needed prior to gifting to reflect separate ownership structures for voting interests or to delineate rights to appoint managers or board members.
3. Creating and Administering Trusts
When gifts are made to trusts for the benefit of family members, rather than outright to those individuals, it is important that certain formalities be observed in administering the trust. The donor should not retain control over the trust or its assets – meaning that the donor cannot control or influence distributions made by the Trustees to the beneficiaries.
Asset management generally needs to be approached differently for a trust than for an individual – to reflect the interests and needs of multiple beneficiaries (present and future) and to account for longer-term planning and growth, especially when a trust is created to last for multiple generations. Depending on the structure of the trust agreement, the Trust may have separate income tax reporting as a fiduciary, which may require some level of coordination with the donor (if the trust is a grantor trust) or with the beneficiaries (if the trust is a non-grantor trust).
If your current estate plan does not include trust agreements that satisfy your specific needs and goals, and/or if your current trusts due not provide flexibility to address future changes to your family and/or the tax laws, new trust agreements may be needed. Although January 2026 feels distant, we all know that time flies, and this kind of advanced estate planning takes time.
The attorneys at Sessa & Dorsey are ready to speak with you and your advisors to discuss specific strategies to preserve your remaining lifetime exemption amount. Do not delay if you want to ensure that your estate can avoid the consequences of a 2025 sunset. Contact us at (443) 589-5600 to get started.
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