US Tax Inflation Increases Exemption Amounts and Opportunities

Article 26 October 2022 Experience: Tax

The Internal Revenue Service (IRS) recently unveiled its inflation adjustments for the 2023 US federal tax year. The thresholds for several key tax provisions are increasing considerably, which is unsurprising given the fast pace of consumer price growth and other relevant measures of inflation. Generally speaking, for high-wealth households with US citizen or domiciled individuals the 2023 adjustment translates into a nearly US$1 million increase in the amount of money an individual can shield from the US federal estate, gift, and generation-skipping transfer tax (collectively, “transfer tax”); specifically, the lifetime transfer tax exemption for 2023 will rise to US$12.92 million, up from US$12.06 million in 2022. Under current law, the exemption amount is computed by reference to a notional US$10 million exemption amount indexed to inflation from 2010; however, this exemption amount is scheduled to revert to one-half that amount as of 1 January 2026 (i.e. US$5 million indexed for inflation). We see many clients who remain motivated to explore and implement ways to efficiently utilise this increased exemption amount before the planned reversion date. This motivation has been amplified while markets have depressed values and interest rates are rising.

Non-US citizens who are not domiciled in the United States are potentially liable to US federal estate tax only on US-situs assets held or deemed held at death. For these individuals, however, the lifetime exemption amount from US federal estate tax remains at a paltry US$60,000. Our recommendation tends to be to encourage these non-US clients to shield against this US federal estate tax liability by investing indirectly through blocker companies or, alternatively, through estate-tax remote trusts if the goal is to hold assets until one passes away; however, for those looking to survive and plan exits during the course of the investment, optimising US federal income tax on exit remains the priority and US federal estate tax optimization is a secondary consideration at best.

For an individual considering renouncing US citizenship (i) the average annual net income tax liability threshold under the 5 year income tax test has increased to US$190,000, and (ii) the amount of gain that can be excluded from gross income if he or she is a covered expatriate subject to the deemed sale rule has increased to US$821,000.

Additionally, individuals should be pleased to know that the annual exclusion amount for gifts will be US$17,000 in 2023, up from US$16,000 in the 2022 tax year. While US citizen spouses continue to enjoy an unlimited marital deduction for gifts made between each other, the annual gift tax exemption on gifts to non-US citizen spouses remains limited to a notional amount of US$100,000 indexed yearly for inflation (in addition to the lifetime transfer tax exemption amount, which could also potentially be used to make gifts to a non-US citizen spouse). In 2023, this means the first US$175,000 of gifts to your non-US citizen spouse are essentially exempt from US federal gift tax. As a reminder, those gifts must be of “present interest” (generally meaning outright gifts not gifts in trust) to qualify for the annual exclusion amount.

Another inflation adjusted amount which is typically of interest to American citizens working abroad, the foreign earned income exclusion has been increased to US$120,000.

If you have any questions on this topic, please speak to your usual Withers contact, or get in touch with either of the authors of this article.

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