2023 estate tax exemption increases by almost $1 million

Inflation-adjusted increases for 2023

Rising inflation has resulted in the following increases that could affect high-income individuals and their estate and gift tax planning for 2023:

• The estate tax exemption increases to $12.92 million, up from $12.06 million in 2022.
• The annual exclusion for gifts increases to $17,000, up from $16,000 in 2022.
• For gifts to a noncitizen spouse, the annual exclusion is $175,000, up from $164,000 in 2022.
• The top individual tax rate of 37% will apply to income over $578,125 for single filers, up from $539,900 in 2022, and to income over $693,750 for married couples filing jointly, up from $647,850 in 2022.
• The alternative minimum tax exemption increases to $81,300, up from $75,900 in 2022.
• The foreign earned income exclusion increases to $120,000, up from $112,000 in 2022.

Background

In 2011, the unified lifetime exemption amount was indexed for inflation. More recently, the Tax Cuts and Jobs Act of 2017 (TCJA) doubled the exemption amount for decedents dying and gifts made between 2018 and 2025. Unless Congress acts, the exemption amount will revert to the pre-TCJA amount in 2026. The TCJA also increased other amounts benefiting both high- and low-income individuals for 2018 through 2025, setting the stage for intense negotiations in Congress with respect to the sunsetting of these provisions at the end of 2025.

Planning for uncertainty

The nearly $1 million increase in the lifetime unified exemption for 2023 represents a little more than a 7% increase, which tracks with the average overall inflation rate so far this year. When the TCJA was enacted, estimates for the estate tax exemption amount were based on an inflation rate of about 3%, which would have put the exemption at about $13.1 million by 2025. That amount likely now will be closer to $14.2 million if inflation continues to increase (assuming an average rate of 5% inflation over the next two years).

When the sunset provision of the TCJA takes effect in 2026, a similar increase in inflation would reduce the estate tax exemption amount to $7.1 million. With control of Congress potentially shifting in the upcoming midterm elections and a presidential election in two years, the certainty of the exemption amount (and possibly the estate tax itself) remains in doubt. Given the potentially wild swing in the available estate tax exemption amount in the coming years, it might be prudent to take advantage of the very certain increases, such as the almost $1 million that will be available in January to make tax-free gifts during 2023, that allow for a greater transfer of wealth.

While making large gifts in 2023 to use most, if not all, of the available limit can reduce estate tax, taxpayers need to retain sufficient core capital to meet their own lifetime needs especially considering future inflation. One technique married couples can use to hedge against future inflation is for each spouse to contribute assets to a spousal lifetime access trust (SLAT) for the benefit of the other spouse. By contributing assets to a SLAT, exemption limits are used up currently, and because a SLAT primarily benefits the grantor’s spouse as the current beneficiary of the trust, the SLAT provides easy access to liquidity for the couple. Additionally, assets can be sold to a SLAT, providing another avenue to access trust funds.

Looking ahead

Higher inflation has presented an opportunity for individuals to review their estate and gift tax plans to see whether changes can be made to reduce estate taxes. However, the economic and political uncertainties over the next few years and the looming sunset of the higher lifetime exemption complicate decision-making. Gifting, even into a SLAT, requires careful consideration of one’s entire estate plan and financial picture. The benefits, though, of taking advantage of increased exemptions can be a great multiplier against potential taxes. Therefore, taxpayers should consult with their advisers to review their estate plans and evaluate how best to harness what is known today and to protect against future risk.