$860,000 – that is the amount of the increase in the gift, estate, and generation-skipping transfer (“GST”) tax exclusion that came into effect on January 1st when the exclusion increased from $12.06 million for 2022 to $12.92 million in 2023. This one-year increase is unprecedented and is more than the entire exclusion in 2001. For a U.S. married couple, the total increase is $1.72 million.

Why the large increase? Inflation. The lifetime exclusion and the annual gift tax exclusion (which was $16,000 in 2022 and increased to $17,000 in 2023) are both adjusted annually for inflation.

Windfalls without a catch are uncommon, and when they occur, wisdom dictates that we determine how to optimize them best. Many of our clients used substantially all of their exclusion in recent years funding gift trusts and dynasty trusts in the wake of the 2020 election and in anticipation of the scheduled 2026 decrease in the exclusion amount to $5 million, adjusted for inflation. But now taxpayers have an additional amount of exclusion to utilize. We suggest the following:

• Topping-off Gift Trusts. Making additions to existing gift trusts and applying available exclusion to the gift is a simple way to utilize the additional exclusion amount. The question is how to leverage the additional exclusion. Transfers of minority/non-controlling interests in entities are customarily valued at a discount due to lack of control and marketability. And transfers of assets with appreciation potential optimize the long-term benefit of a gift. Note, however, that assets transferred to a gift trust carry their basis with them and no future basis adjustment at death is available.
• Intra-family Loans. Loans to family members for home purchases and business start-ups and financed asset sales to irrevocable grantor trusts are common. The loans can, however, become a bit of a nuisance to maintain. Consider making a gift to an individual family borrower to repay a family loan and canceling loans to irrevocable grantor trusts in amounts covered by the additional exclusion. While debt forgiveness is typically subject to income tax, neither repayment of a debt nor cancellation of debt between a grantor and a grantor trust triggers income tax.
• Funding an Irrevocable Life Insurance Trust. Owning life insurance in an irrevocable life insurance trust (“ILIT”) removes the insurance proceeds from the insured’s taxable estate, but the policy must be maintained in the trust. Typically, annual contributions within the annual gift tax exclusion amount are made to the trust, and the trustee then provides notices of the contributions to beneficiaries and subsequently pays the annual policy premium. The contribution, notice, and payment cycle repeats, and repeats, and repeats. Sometimes there are time crunches and record of ILIT contributions and beneficiary notices are not always maintained. If a larger contribution is made to the trust in an amount to cover projected premium payments and available exclusion is applied to the contribution, the gift is tax-free and annual contributions and notices are no longer required. The trustee can simply pay the annual premium each year from the liquid assets in the trust.
• Generation-Skipping Trust Refresh. The objective of a multi-generational dynasty trust is to apply GST tax exclusion to the trust when it is established so it is fully exempt from the GST tax for the entire duration of the trust. Occasionally the available exclusion is insufficient to fully exempt the trust. Fortunately, with the recent increase in the exclusion amount, part or all of the increase can be applied to an existing trust to wholly exempt the trust from the GST tax.

Each strategy will require filing a Gift Tax Return (Form 709) to report allocation of exclusion, but no tax will be due provided the value of the gifts does not exceed the available exclusion. Which strategy to use depends on each individual’s prior gifting and current goals.

In addition to the increased inflation adjusted exclusion amount, interest rates have risen to moderate inflation, and there are additional planning strategies to utilize in a higher interest rate environment which we will discuss in an upcoming article.

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