The Impending Estate and Gift Tax Exemption Sunset – Will it Happen?

The Impending Estate and Gift Tax Exemption Sunset – Will it Happen?

As you may know, the current U.S. estate and gift tax exemption allows individuals to transfer up to $12.92 million (i.e., $26M for a married couple) without incurring federal estate or gift taxes. This exemption amount has significantly increased in recent years, largely due to provisions of the 2017 Tax Cuts and Jobs Act (TCJA) from Trump’s first term.

Like several TCJA provisions, the higher estate tax limit is due to sunset in 2025. Barring congressional action, the exemption amount will return to about $6.8 million, adjusted for inflation, in 2026. Similarly, the current 40% maximum gift and estate tax rate will increase to 45%.

A Brief History Lesson

In the Election of 2012, President Obama won re-election over Mitt Romney.  While the Democratic party controlled the Senate (Harry Reid was Speaker), the Republicans controlled the House (with John Boehner as Speaker).  Following that, in 2013, provisions of the Patient Protection and Affordable Care Act  took effect that imposed the Medicare tax of 3.8% (formerly a payroll tax) on capital gains of high-income taxpayers.   The result of this impending tax increase was a flurry of activity in the Estate Planning and M&A markets as Entrepreneurs and high net worth individuals proactively moved capital to avoid the incremental tax.

While the news this week seems to focus mainly on Trump’s Cabinet nominations, the reality of this impending Tax increase is – or should be – front and center for your clients.  

Without action from Congress, the current available federal exemption will be cut in half beginning on January 1, 2026. Although the Republicans taking the majority in the Senate and the House may increase the likelihood of extending provisions under the TCJA, it may be late into 2025, or even early 2026, before there is any certainty.

So, the bottom-line question is:  Will Congress extend it or not?   

While the majority of people I’ve asked this question to seem highly confident that the Republican majority extends this provision, which makes sense.   However, for Business Owners with a potential federal estate tax liability under current law, there is a challenge with taking a “wait-and-see” approach through 2025 – It runs a significant wealth-preservation risk:  loss of the $14 million additional exemption for married couples or $7 million for individuals that is available today…

To mitigate that risk, and to avoid a repeat of 2012 (hurried planning or overwhelmed attorneys and other advisors) towards the end of 2025, clients seeking to maintain flexibility as the sunset deadline approaches, in my opinion should consider getting their planning and any necessary documents ready now, and then waiting to make transfers of property until closer to the end of 2025, when the fate of the TCJA and its sunset may be more certain. Whether the election results ultimately usher in a sunset, or sunrise, of the TCJA estate tax exemptions, clients would be best served to meet with their advisors today to put together a game plan.

Impact on M&A Activity: Timing and Structuring

If 2025 follows what happened in 2012, the looming reduction in the tax exemption is likely to spur a wave of activity in the M&A market. Business owners and investors, particularly those with substantial assets, will be motivated to engage in strategic transactions before the sunset occurs.

Here’s how this could play out:

1. Accelerated Deals and Transactions: Many business owners may accelerate the sale or transfer of business interests to take advantage of the higher exemption before it expires. Family-owned businesses – which often have complex ownership structures – may look to divest or reorganize their holdings within the next few years. This rush could lead to an uptick in M&A activity, with business owners seeking to reduce the taxable estate and preserve wealth for future generations.

2. Increased Interest in Structuring Deals as Gifts: Given the potential reduction in the exemption, owners may opt to gift shares or equity stakes in their businesses to heirs or trusts, rather than selling them. This would allow them to take advantage of the current higher exemption and reduce the overall estate tax burden. For M&A professionals, this could mean a rise in transactions structured as gifts or partial gifts rather than traditional asset sales.

3. Valuation Considerations: The anticipation of changes to the estate and gift tax exemption could lead to increased volatility in business valuations. As high-net-worth individuals and business owners rush to complete deals, the increased demand for business transfers could drive up valuations, especially for family businesses or those with significant non-liquid assets. Conversely, there may be a rush to sell undervalued businesses if owners believe that the sunset will reduce the potential benefit of their transactions.

4. Increased Use of Family Limited Partnerships (FLPs) and Trusts: To maximize the use of the estate and gift tax exemption, many owners of closely-held businesses might turn to estate planning techniques such as Family Limited Partnerships (FLPs) or the creation of irrevocable trusts. These mechanisms allow individuals to transfer assets in a way that minimizes gift and estate tax liability. However, they can also be used to facilitate M&A transactions by shifting ownership stakes before the exemption changes, which could encourage more structured deals.

With my experience in the Capital Markets, and now also as a Certified Exit Planning Advisor (CEPA),  I’m happy to be a resource to you in helping your clients weigh their options.  Please let me know if you have a client who would like meet for lunch, coffee or a beverage just to understand the state of the markets and what their options are.