Each year, the IRS considers inflationary adjustments to the estate and gift tax exemption amount and gift tax annual exclusion amount. As you contemplate your estate planning or making gifts during this new year, here are the numbers that were published for 2025:
2025 Exemptions and Exclusions: The estate and gift tax exemption amount has increased from $13.61 million per person to $13.99 million per person in 2025. The 2025 generation-skipping transfer tax (GST tax) exemption amount has also increased to $13.99 million per person. The incoming administration is predicted to extend these heightened exemption amounts. However, if no action is taken by the new Congress to change the current law prior to December 31, 2025, these heightened exemption amounts will revert to pre-2017 Tax Act levels of $5 million per person (as upwardly adjusted for inflation) on January 1, 2026. Projections show that the exemption would be approximately $7 million per person at that time. The current higher exemptions provide an excellent opportunity for planning lifetime transfers to minimize total taxes.
Every year, each person is allowed to make a gift to another person up to a certain amount without incurring any gift tax liability – this is called the “annual exclusion.” The annual exclusion is a powerful tax-saving tool because the person making the gift can transfer wealth without using any of his or her estate and gift tax exemption amount and without needing to file a gift tax return. In 2024, the annual exclusion was $18,000, but the IRS announced that the annual exclusion will be $19,000 in 2025. This means that a donor can give up to $19,000 to an unlimited number of persons without incurring gift tax or the obligation to file a gift tax return. For example, married couples can give each child and grandchild up to $38,000 in 2025 without incurring any gift tax liability and without using any estate or gift tax exemption.
January and February 2025 Interest Rates: While interest rates over the past few years have remained relatively low, they have slowly increased since the historic lows in 2020. The IRS released the adjusted applicable federal rates (AFRs) for January 2025: the annual short-term (under three years) is 4.33 percent; annual mid-term (three to nine years) is 4.24 percent; and annual long-term (more than nine years) is 4.53 percent. These will adjust every month.
Planning Opportunities: Current factors provide unique opportunities to minimize your tax exposure. While the incoming administration is predicted to extend the current heightened exemption amounts, single individuals with an anticipated gross estate in excess of $7 million and married couples with a combined anticipated gross estate in excess of $14 million should consider taking advantage of the higher exemption amounts currently in effect:
- Spousal Lifetime Access Trust (SLAT): A SLAT is an irrevocable trust created by one spouse who gifts assets to a trust for the benefit of the other spouse (the beneficiary spouse). The value of the property gifted to a SLAT is determined at the time the SLAT is funded and uses the estate and gift tax exemption available as of the date of such gift. Utilizing the current heightened exemption amount, a donor spouse can transfer up to $13.99 million (less any prior lifetime gifts) in 2025 without incurring any gift tax liability. A SLAT allows the beneficiary spouse to receive distributions from the trust, while the trust assets, including appreciation on those assets, are simultaneously excluded from the beneficiary spouse’s gross estate and, therefore, are not subject to estate tax at the beneficiary spouse’s death. A SLAT is frequently structured as an IDGT (see immediately below).
- Intentionally Defective Grantor Trust (IDGT): Another technique to consider is a sale to an IDGT. This technique starts with an initial seed gift to the IDGT (typically 10% of the value of the property that will be sold to the IDGT), followed by a sale of assets to the IDGT in return for a promissory note with interest payable at the AFR. The IDGT is designed to exclude its assets from the estate of the individual who created the trust, but it is “defective” for income tax purposes so that the income of the trust will be taxed to that individual. When the individual trust creator pays the tax on the trust’s income, the higher and more compressed tax rates for trusts are avoided, preserving more trust assets and income for the enjoyment of the beneficiaries rather than being liquidated to pay taxes.
The use of the sale technique provides flexibility in the event the existing heightened estate and gift tax exemptions are lowered before January 1, 2026. For example, if the estate and gift tax exemptions are reduced either before or at the end of 2025, an amount of the promissory note less than the taxpayer’s remaining higher gift tax exemption could be quickly gifted to the IDGT, thus cancelling the gifted portion of the promissory note. An outstanding promissory note provides the flexibility to get low-basis assets from the IDGT back to the grantor of the IDGT and holder of the note. Swapping all or a portion of the note in exchange for low-basis assets of equal value held by the IDGT provides the creator an income tax basis adjustment if the assets then remain in the grantor’s estate until death, but the estate tax effect is neutral because the value of assets in the grantor’s estate did not change as a result of the swap.
If the IDGT is properly structured to take advantage of the GST tax exemption, it can continue for the benefit of multiple generations without incurring additional estate, gift, or GST taxes at each generational transfer. For this reason, this kind of trust is often referred to as a “Dynasty Trust” or an “Endowment Trust.” While there are many benefits to making provisions for later generations in trust, a prominent benefit is the additional protection trust assets have from a beneficiary’s creditors, including a spouse in the event of divorce.
- Intra-Family Loans: Individuals can take advantage of lower AFRs by making loans to family members or refinancing existing loans. Low interest rate loans can be combined with gifts, resulting in larger transfers without incurring any taxes. While the rates are not as attractive as they were several years ago, they may be lower than a family member might be offered from a bank.
- Gifts to Family Members: While the techniques discussed above are powerful tools to leverage the estate and gift tax exemption, taxpayers should not underestimate the simplicity and effectiveness of making direct gifts to family members. This includes transferring assets outright, making gifts to irrevocable trusts for family members’ benefit, or forgiving outstanding intra-family loans.
With rising interest rates and inflation, other strategies suited to higher interest rate environments include:
- Charitable Remainder Trusts (CRTs): A CRT is a type of “split-interest transfer” in which the creator of the trust initially reserves the right to receive annual payments for a specified term, and then charity receives the remaining value at the end of the term. The charitable deduction for the creator’s income tax equals the value of the charity’s remainder interest in the CRT, which is calculated using the §7520 rate (5.2% for January 2025). Larger values will pass to charity when interest rates are higher, which means that a higher income tax charitable deduction and deferring or potentially eliminating capital gains.
- Qualified Personal Residence Trusts (QPRTs): With this strategy, a personal residence is transferred to the QPRT while the right to live in the home rent-free is retained by the owner for a specified term. When this term ends, the residence passes to the designated beneficiaries (typically, descendants). The transfer of the residence is considered a gift, but the value of the gift is reduced by the value of the owner’s retained rights. Lower gift amounts result during higher interest rate environments, meaning that less estate and gift tax exemption is used at the time of the transfer. QPRTs can provide valuable estate-tax savings if the owner outlives the initial term, then the entire value of the residence is removed from the owner’s estate.
As our calendars have flipped to 2025, let’s start the conversation about tax-saving estate planning techniques that are available to you during these volatile times. Please contact one of Michael Best’s Wealth Planning attorneys to explore strategic planning opportunities, especially if you are considering making lifetime gifts.