The IRS recently announced the annual gift tax exclusion is increasing in 2024 due to inflation. The exclusion will be $18,000 per recipient, the highest exclusion amount ever.

In addition, the estate and gift tax lifetime exemption will increase to $13.61 million per individual for 2024 gifts and deaths, up from $12.92 million in 2023. This means a married couple can shield up to $27.22 million without having to pay any federal estate or gift tax. The current federal tax rate is 40%.

It is important to note these lifetime exemption amounts are due to sunset at the end of 2025 to pre-Trump levels, unless Congress votes to extend them. Most advisors estimate this sunset would cause the exemption amounts to be cut by half.

This potential sunset causes a lot of questions from farm couples whether they should consider using some of their gift exemptions now, before they potentially lose a large amount they can gift away, tax-free. Let’s dive into some examples you might consider:

Cash

For those holding onto cash you can use your annual gift exclusion to give away up to $18,000 per recipient. For example, if a married couple has three children and six grandchildren, they may transfer $324,000 in 2024 without touching their combined $27.22 million gift tax exemption. Not only are the assets removed from the taxpayer’s taxable estates, but the future appreciation from those assets also avoids gift and estate taxes. Since cash is not an asset that appreciates in value, nor an asset many family farms hold an abundance of, we tend to consider other strategies for using the annual gift exclusion.

Entity ownership units

From a transition planning standpoint, family entities such as corporations, limited liability companies, and limited liability partnerships are used not only to protect the assets but also to transition the ownership more easily via “units” versus gifting actual assets such as pieces of farm equipment or parcels of farmland. To boot, the IRS recognizes valuation discounts for the fact units of a closely held family entity are less marketable to sell to non-family members. We’ve seen legal advisors apply discounts ranging from 15% to upwards of 40% which allows you to effectively gift more away, on paper.

For example, let’s say your tax advisor is comfortable applying a 30% discount on your LLC units. You could then effectively gift $23,000 in actual value but keep it within the $18,000 annual gift exclusion, on paper. If you make an annual gift more than the exclusion amount, then you must file a gift tax return to notify the IRS you are using part of your lifetime exemption amount, but still tax free. Larger, more significant gifts of entity units can also be discounted using the valuation discounts noted above.

Depreciable hot assets

Depreciable farm assets such as equipment and grain could be another strategy, especially if you don’t necessarily need the equity form those assets. The reason being is these assets are typically subject to higher taxes from income recapture from the depreciation and self-employment taxes in the case of grain. Some farmers I work with will walk through hot coals to save paying tax. Using your lifetime gift exemption will allow you to do this by minimizing the tax from the sale of these assets. One tradeoff is the current cost basis in the assets will carryover with the gift so the new owners will not get a new step-up in basis. But, you’ve also transferred the equity in those assets to help the next generation and perhaps save them managing estate taxes from those assets in the future.

Part sale, part gift

What about a farm, or ownership in your farm business? Consider a part sale, part gift to set the price at the value you believe to be fair for your family. If this is at a discount to fair market value, use part of your gift exemption to set your price while the part sale maintains your income. Any gain from the sale is treated as capital gain, which if sold using a private sale contract can be spread over the term of a contract more favorably.

Lifetime exemption

If you are considering a larger gift, don’t make the mistake of using both spouses’ exemptions. For example, if you make a $13.6 million gift using $6.8 million from each spouse, then each spouse is left with no lifetime exemption if they sunset to $6 or $6.5 million in 2026. Whereas, if you just use one spouse’s exemption, you will still have the other spouses $6 or $6.5 million exemption available, tax free.

As always, every situation is different and unique so please consult with your respected tax and legal advisors before making a large gift from your estate.

Downey has been helping farmers and landowners for the last 23 years with their family farm transition, estate planning, leasing strategies, and general farm advising. He is the co-owner of Next Gen Ag Advocates and an associate of Farm Financial Strategies. Reach Mike at [email protected].