The Tax Cuts and Jobs Act, entitled the “Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (the Act), has passed, providing exceptional opportunities for our estate planning clients.
Many notable provisions of the Act become effective on January 1, 2018, and several key provisions sunset on December 31, 2025. We strongly advise clients not to wait for the sunset at the end of 2025 to take advantage of this significant estate planning opportunity, because a change in Congress could bring a sooner end to this opportunity than the sunset. Below, we have provided a preliminary discussion of the Act’s important changes to the tax law that affect our estate planning clients.
Temporarily Increased Exemption from Gift and Estate Taxes
The Act doubles each taxpayer’s exemption from estate and gift tax through 2025, enabling a taxpayer to give away up to $11.2 million (or $22.4 million per married couple; base exemption amount of $10 million, adjusted for inflation since 2011) during life and at death without incurring federal gift or estate tax.
After 2025, the increased exemption amount reverts to the current law that would have provided an exemption in 2018 of approximately $5.6 million per individual and $11.2 million per married couple, indexed for inflation.
The Act continues to permit a “step-up” in basis on assets inherited from a decedent.
Temporarily Increased Exemption from the Generation-Skipping Transfer Tax
Another important aspect of this special opportunity is the expanded generation-skipping transfer tax (GSTT) exemption. Similar to the gift and estate tax exemption, the GSTT exemption amount affecting transfers to grandchildren and more remote generations also doubles in 2018 to $11.2 million per individual or $22.4 million per married couple. This opportunity also has a time limitation because the GSTT exemption amount reverts after 2025 to the current exemption amount (indexed for inflation).
The Act does not impose any limitation on the duration of a generation-skipping transfer trust beyond that imposed by state law. Thus, it is still possible under the Act to create a generation-skipping transfer trust that will continue in perpetuity if the proper state law is applicable.
The Act did not change portability. “Portability” is the ability for a surviving spouse to use the unused gift and estate tax exemption amount of a previously deceased spouse.
New Rules for Charitable Contributions
The Act allows taxpayers to deduct charitable contributions of cash up to 60 percent of their adjusted gross income—an increase of 10 percent from current law.
Changed Tax Brackets and AMT
The Act changed the individual tax brackets. There are still seven brackets, but the top tax rate is 37 percent, which applies to single filers over $500,000 and married couples over $600,000. The personal exemption is eliminated, but the standard deduction is increased to $12,000 for single filers and $24,000 for joint filers.
The individual Alternative Minimum Tax (AMT) remains intact, but the exemption amounts have been temporarily increased to $109,400 for married couples and $70,300 for single filers.
The Act suspends through 2025 a number of existing deductions, including those for student loan interest, medical expenses, moving expenses, alimony, most casualty losses, and all other miscellaneous itemized deductions subject to the 2 percent floor.
The Act reduces the availability of interest deductions in respect of mortgages put in place after December 15, 2017, limiting the deduction to interest on combined principal acquisition indebtedness of up to $750,000 on a principal residence and one other qualified residence. The interest deduction for home equity loans is suspended.
In a development important to our clients in states with high income tax rates, such as California, Connecticut, New Jersey and New York, the Act significantly limits deductions for state and local income taxes, sales taxes and property taxes. Both single and joint filers are permitted a maximum itemized deduction of $10,000 for their state and local taxes.
The Act affects the international tax regime. The Act provides for a transition to a modified territorial international tax system, which exempts from taxation certain foreign source dividends.
Pass-Through Businesses Benefits are Limited
Although the Act alleviates some tax burdens for pass-through business owners to try to match the Act’s benefits for corporations, the benefit is limited. Pass-through business owners may deduct 20 percent of qualified business income, but are subject to a wage limitation that is phased in for joint filers whose income exceeds $315,000 ($157,500 for individual filers). Owners of service businesses are phased out of the benefit entirely when their income exceeds $415,000 for joint filers ($207,500 for individual filers).
Private Equity Tweaked
As seen in the preliminary bills from the House and Senate, the impact on “carried interest” benefits is minimal. Under the Act, to obtain favorable tax treatment for carried interest, the investment must be held at least three years.
529 Plans Expanded
The Act expands the permissible uses of section 529 plans. 529 accounts will continue to be available to pay college tuition, but now may also be used to pay up to $10,000 per year on tuition at elementary and secondary schools.
Opportunities for Estate and Tax Planning:
- Clients should consider additional gifting transactions starting in 2018 to take advantage of the historic doubling of the exemption amount under the Act. This opportunity is set to end after 2025, but that sunset may come sooner with legislation from a new Congress. Connecticut residents should consider the application of the Connecticut gift tax.
- The benefits of funding dynasty trusts that last for generations will be amplified with the increased GSTT exemption amount. Again, there is only a limited time for this historic opportunity to exempt such a large amount of assets for generations. Note that the current opportunity for using the long term GSTT exemption combined with the gift tax exemption offers powerful leveraging of the exemptions and remains available under the Act.
- Business owners should have their estate plans reviewed by our team to see if the Act has affected the tax efficiency of their ownership structure or has created opportunities for the client.
- All clients should have their estate plans reviewed to determine whether the Act has changed the distribution of their estates. Note that the increase in estate tax exemption could alter the wishes of a married couple with respect to the division of an estate between a spouse and a “credit shelter trust.” Similarly, all clients who reside in states with state estate tax should review the impact of the increased federal exemption and their “credit shelter trust” on their state estate tax burden.