In light of the federal estate, gift and transfer tax exemptions scheduled to sunset at the end of 2025, many wealthy clients are consulting with their attorneys regarding making gifts that maximize the largest exemption amounts in United States history before this potential sunset. While these exemption amounts have varied over the past two decades, one trend has remained constant: a steady increase in the exemption amount (omitting calendar year 2010 as an anomaly, with federal estate tax law giving executors the choice to opt-out of the federal estate tax; however, this choice forfeited the step-up in basis on those estate assets for a decedent who died in 2010 and for whom such opt-out was elected). This noteworthy trend of rising exemption amounts is slated to end and be cut in half in accordance with the expiring provisions of the Tax Cuts and Jobs Act of 2017 (TCJA). The federal estate tax system is relatively straightforward, given an estate is taxed at 40% for all assets includible in the taxable estate in excess of the decedent’s remaining exemption amount. The same cannot be true, however, of the remaining fifteen states with a state estate tax and/or inheritance tax (Maryland being the only state currently with both) because of these systems’ graduated rates, ‘cliff’ taxes, lookback rules and other complications for clients and their advisors. Notably absent though from every state (except for Connecticut) is a gift tax regime. Clients with not only an anticipated taxable estate for federal estate tax purposes, but also a taxable estate for state estate tax purposes, may be able to leverage this difference since a state’s lack of a state gift tax system can help maximize efficiency in their estate plans.

Most clients look at their exemptions as their only opportunity to gift assets and never consider the impact of making taxable gifts during life. The math, depending on the state’s estate tax laws, or lack thereof, can be truly compelling. Two forms of gifts could result in gift taxes being owed: 1.) Gifting amounts above the annual exclusion (in 2025, $19,000/year per donee per donor, or $38,000 per donee for a married couple); or 2.) Gifting additional assets after the donor has exhausted his lifetime gift tax exemption amount. Both instances would require filing a federal gift tax return, Form 709, but generally only the latter would result in the donor needing to pay the gift tax. Instead, a donor may use some, all, or none of their federal gift tax exemption (in 2025, $13.99 million during his lifetime with no gift tax implications).

If a taxpayer chose to make a gift valued in excess of the federal annual exclusion amount, and after utilizing all his federal gift tax exclusion amounts, such a gift will be taxable. These gift taxes would be deemed exclusive because the tax is due only based upon the value of the gift, not on the gift taxes paid, thus, not reducing the amount the donees receive. For example: in 2025, Ben wants to make an additional $3 million transfer of his assets to his two sons more than the federal annual gift tax exclusion amount, and after Ben has already utilized his entire federal gift tax exemption amount. In making the $3 million gift to his sons, the sons still receive the full $3 million, but Ben must now pay approximately $1.2 million of gift taxes (at the 40% federal gift tax rate), which Ben must pay from other assets. This, in itself, is valuable leverage because federal gift taxes paid is not deemed to be an additional gift by the donor (although, note that any gift taxes that Ben pays within a 3-year period prior to his death would be included in his taxable estate for federal estate tax purposes).

Contrast this example now with the federal estate tax regime which is classified as inclusive. If Ben passes away and leaves the $3 million of his assets to his sons, the full amount will not go to his sons; instead, only $1.8 million would be transferred to them after the federal estate taxes were paid (at the 40% estate tax rate). In this example, for the same amount, Ben distributes about 67% more to his sons by choosing to pay federal gift tax now, rather than his estate paying the federal estate tax at his death. Additionally, gifted assets during a donor’s lifetime grow outside of the donor’s taxable estate, making the math even more compelling.

To illustrate the more complex demands of estate planning in some states, while portability is available for federal estate purposes for the surviving spouse to elect[1], it cannot currently be leveraged at the state level, except in Maryland and Hawaii. This makes state estate tax exemptions effectively a “use it or lose it” proposition. For example, New York has an ‘estate tax cliff’ in which once the decedent’s taxable estate exceeds 5% of the state estate tax exemption amount at the time of the decedent’s death, the entire taxable estate is subject to the New York state estate tax. New York’s current individual exemption is $7.16 million per decedent, so if the taxable estate were valued at more than $7.518 million, the New York estate tax exemption disappears, and the decedent’s entire taxable estate becomes exposed to this New York estate tax. Contrast that, however, with New York’s gift tax, which does not exist. Let us review another example to illustrate the impact of being proactive with making taxable gifts vs. leaving the assets within the taxable estate for a client in a state, such as New York, with a state estate tax. Suppose the following:

• Client Name: John Snow
• Current Net Worth: $60 million
• Current Assets in Taxable Estate: $60 million
• Current Assets Outside Taxable Estate: $0
• Current Federal Estate and Gift Tax Exemption Amount Remaining: $13.99 million
• Current New York Estate Tax Exemption Amount Remaining: $7.16 million
• Age: 70
• Life Expectancy: 85
• State of Domicile: New York

Scenario 1: John does no lifetime gifting from his taxable estate.

• Up-front federal gift tax due: $0
• Up-front state gift tax due: $0
• $10.3M[2]: Assumed Applicable Federal Estate Tax Exemption Amount Upon His Death at His Life Expectancy
• $143.8M[3]: Total Assets Inside Taxable Estate Upon His Death at His Life Expectancy
• $44.2M[4] LESS: Total Federal Estate Tax Due Upon His Death at His Life Expectancy (after accounting for deducting New York estate taxes paid)
• $23M[5] LESS: Total NY Estate Tax Due Upon His Death at His Life Expectancy
• $76.6M: Total Assets from Inside the Taxable Estate After Federal and State Estate Taxes Paid
• $0 PLUS: Total Assets Outside Taxable Estate at Life Expectancy Upon His Death at His Life Expectancy
• $76.6M: Total Estimated Net Assets to Heirs

Scenario 2: John Gifts $25 million in 2025 and pays federal gift tax of 40% on the amount above $13.99 million.

• Up-front federal gift tax due: $4.4M[6]
• Up-front state gift tax due: $0
• $73.3M[7]: Total Assets Inside Estate Upon His Death at His Life Expectancy
• $24.6M[8] LESS: Total Federal Estate Tax Due Upon His Death at His Life Expectancy (after accounting for deducting New York estate taxes)
• $11.7M[9] LESS: Total State Estate Tax Due Upon His Death at His Life Expectancy
• $37.0M Total Assets from Inside the Estate After Federal and State Estate Taxes Paid
• $59.9M[10] PLUS: Total Assets Outside Estate Upon His Death at His Life Expectancy:
• $96.9M: Total Estimated Net Assets to Heirs:

As observed with the facts and circumstances of this case, making gifts in 2025 permits John to transfer an additional approximately $20 million to heirs despite incurring an up-front gift tax of $4.4 million. John has elected to take advantage of the transfer tax misalignment between federal and NY state laws to transfer about 27% more to his heirs.

As advisors, we aim to navigate clients through these planning opportunities and help them implement appropriate strategies to align with their objectives. Regardless, if you are confronted with the decision to choose a regime, paying federal estate taxes at death or gift taxes during life, the absence of gift taxes at the state level can produce outstanding estate planning leverage that is not commonly understood. The rationale to be proactive on the misalignment with state estate and gift taxes would include:

1.) Shifting high appreciation assets, sooner than a client otherwise might.

2.) Removing the prospect of future adverse transfer tax changes at the federal or state level.

• Mitigating transfer tax risk and securing some level of ‘tax assurance’ today locks in the future growth of the assets in a transfer tax-free realm. Gifting away assets would need to be evaluated with potentially keeping the assets in the estate to secure the step-up in basis at death.

3.) Prudent Basis Planning.

• Basis planning remains critical given one of the tradeoffs of shifting assets out of your estate is sacrificing the step-up in basis[11]. Two strategies to help address this issue would be:

1. a) Incorporating a substitution/swap grantor power in the trust[12]. A swap power provision helps replace high-basis assets in your client’s taxable estate in exchange for assets of equivalent value that have a low basis inside the grantor trust.
2. b) Purchasing Life Insurance inside the trust. Life insurance mitigates basis issues in trusts because of the tax-free nature of the death benefit afforded in IRC Section 101.[13]

Bio: Andrew Manganelli is the Director of Financial Planning for Park Avenue Capital. He oversees the firm’s planning philosophy, capabilities, and strategic thinking. His primary areas of interest are in income tax planning, estate and trusts as well as retirement distribution management. Andrew has worked in the Wealth Management field since 2014 and holds his MS, CFP and RICP designations as well as Series 7 and 63. Andrew is a graduate of Boston University with a Double Major in History an Political Science and completed Graduate School at the London School of Economics and Political Science.

Contact Information: andrew.manganelli@nm.com, 914-924-8236.

[1] I.R.C. § 2010(c)(4)

[2] Starting exclusion of $7M in 2026 (after TCJA sunset) growing at 3% each year until age 85

[3] Derived from an inside taxable estate starting balance of $60M and growing at 6% each year until age 85

[4] Assumes a 40% federal estate tax rate, future exemption of $10.3M and state estate taxes are federally deductible. The value is computed as follows: $143.8M – $23M – $10.3M = $110.5M. Then $110.5M x .40 = $44.2M

[5] Assumes the highest New York State estate marginal tax rate of 16% (no exemption allowed due to cliff tax). The value is computed as follows: 0.16 x $143.8M = $23M

[6] The $25M gift less the exclusion amount of $13.99M would result in $11.01M subject to federal gift tax liability. Taking 40% of the $11.01M would be approximately $4.4M in federal gift taxes due

[7] Derived from starting inside taxable estate balance of $30.6M growing at 6% each year until age 85. $35M starts in the taxable estate after the gift, which is reduced to $30.6M after the $4.4M gift tax is paid

[8] Assumes a 40% federal estate tax rate, which applies to the $73.3M remaining in the estate less NY estate taxes paid. The value is calculated as follows: $73.3M – $11.7M = $61.6M. Then $61.6M X 40% = $24.6M

[9] Assumes the highest New York State estate marginal tax rate of 16%. The value is computed as follows: 0.16 x $73.3M = $11.7M

[10] Computed from an outside taxable estate starting balance of $25M and growing at 6% each year until age 85

[11] I.R.C. § 1014(a)(1)

[12] I.R.C. § 675(4)

[13] I.R.C. § 101(a)(1)

This publication is not intended as legal or tax advice. Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting, or tax advisor. Tax and other planning developments after the original date of publication may affect these discussions.