The Tax Cuts and Jobs Act (the Act), which became law in December, significantly increases the federal gift, estate and generation-skipping transfer tax exemptions for transfers occurring in 2018 through 2025. With proper planning, the Act’s increased exemptions present opportunities for additional wealth transfers and tax savings. Under certain circumstances, the Act could also adversely affect existing estate plans. Now is a good time to consider making gifts and to review your estate plan to determine whether it still meets your objectives. In addition, if you are considering making charitable contributions, consider income tax planning issues and opportunities arising under the Act.
What Has Changed?
The Act doubles the lifetime exemptions for federal gift, estate and generation-skipping transfer taxes to approximately $11.2 million per person, adjusted annually for inflation. Accordingly, married couples will be able to transfer a combined $22.4 million to their families free of federal transfer taxes. The increased exemptions are not permanent, however. They are set to expire at the end of 2025 and will return to 2017 levels, adjusted for inflation.
What Has Not Changed?
While the federal estate tax exemption has doubled, state transfer taxes are unaffected by the Act. In states like Illinois that have estate tax exemptions that are lower than the federal exemption but no portability (the ability for the surviving spouse to use a deceased spouse’s unused exemption), proper estate planning remains critical to take full advantage of the state estate tax exemption and minimize state estate taxes.
Planning Opportunities and Limits
Charitable gifts are only deductible if the taxpayer itemizes deductions. Due to the Act’s increased standard deduction from $12,700 to $24,000 for married individuals filing jointly (from $6,350 to $12,000 for single taxpayers and married individuals filing separately) and its $10,000 limit on state and local tax (SALT) deductions ($5,000 for married individuals filing separately), fewer taxpayers will itemize deductions on their income tax returns. Taxpayers who are at least 70 ½ have the option to make contributions of up to $100,000 directly from an IRA to a qualifying charity without including the amount passing to charity in the IRA owner’s gross income. Those who are charitably inclined but who will no longer itemize deductions should consider a direct distribution to charity from an IRA. The amount distributed to charity (up to $100,000) counts against the IRA owner’s required minimum distribution for the year of distribution.
For those who will continue to itemize deductions, the Act increases the federal income tax deduction limitation from 50% of adjusted gross income to 60% if all charitable gifts are made in cash to public charities or other “50% charities.” If a charitable contribution is made in cash or in-kind to a private (nonoperating) foundation or in-kind to a 50% charity, the Act’s increased deduction limitation is not available. While there continue to be tax advantages to giving appreciated assets to charity, individuals contemplating making charitable gifts that may exceed 50% of adjusted gross income should now also consider the potential tax benefits of the Act’s 60% deduction limitation available for all-cash gifts to 50% charities.
Additional Lifetime Gifts
The increased federal transfer tax exemptions apply not only to transfers at death, but also to gifts during life. This provides an opportunity for individuals to make significant gifts to younger generations at little or no gift or generation-skipping transfer tax cost. Most states do not impose a gift tax or generationskipping transfer tax on lifetime gifts. As a result, under the right circumstances, lifetime gifts can also be an effective tool for minimizing state transfer taxes that would otherwise be payable on assets if owned at death. If you created trusts that are not exempt from generation-skipping transfer taxes, such as insurance trusts, consider allocating generation-skipping transfer tax exemption now. No additional gift is required.
The Act’s doubled gift, estate and generation-skipping transfer tax exemptions offer planning opportunities for anyone who has already made significant gifts in trust or who plans to make large gifts in the future. The Act’s exemptions are set to sunset at the end of 2025 (and are always subject to change if the political power shifts in DC). If you plan on taking advantage of the increased exemptions, consider doing so sooner rather than later to avoid losing this planning opportunity.
Potential Adverse Effects to Existing Estate Plans
Depending on how your estate plan is drafted, the Act’s increased exemptions may undermine your original planning objectives. For example, many estate plans are drafted with formulas that adjust as tax laws change. Because the federal estate tax exemption has significantly increased over the years, a formula plan may no longer produce the intended result. For instance, in 2008 a formula bequest to your children of an amount equal to your federal estate tax exemption would have resulted in a bequest of $2,000,000. That same language in 2018 would result in a bequest of more than $11,000,000!
In a state that has its own estate tax, formulas can result in a state estate tax on the first spouse’s death that could otherwise be deferred until the surviving spouse’s death (or even be avoided entirely). In Illinois, the 2008 formula bequest described above would result in an Illinois estate tax of more than $1,000,000 if the first spouse died in 2018. Even more problematic, it is possible a formula could result in more assets passing to your children and grandchildren than you intended at the expense of your spouse.
If your estate plan relies on formulas to allocate assets among various trusts or beneficiaries, consider reviewing these formulas in light of your current financial situation and planning objectives to be sure your goals are met.