On December 22, 2017 President Trump signed the Tax Cuts and Jobs Act which became effective January 1, 2018, although many of its provisions will sunset on December 31, 2025. Most of the changes under the Act affect the federal corporate and personal income tax, but there are changes to other sections of the Internal Revenue Code – including estate, gift and generation-skipping tax — and those are addressed in this first of my two blogs on the Act.
This first installment will focus on the federal, estate and gift tax changes themselves. My second installment will be posted next week and in that I focus on some planning opportunities these changes offer.
Prior to the passage of the Act, beginning January 1, 2018 the exemption from the federal estate, gift and generation-skipping tax would have been $5,600,000. Under the Act, beginning in 2018 the exemption is almost doubled to $11,180,000, per individual, with an inflation-adjustment for future years. For a married couple, in 2018 the combined exemption will be roughly $22,360,000. However, the doubling of the exemption is temporary, so that on January 1, 2026 the exemption will revert to the pre-Act amount, adjusted for inflation.
When the federal estate and gift tax exemption was raised to $5,000,000 at the end of 2010 the number of individuals subject to those taxes plummeted. With a doubling of the exemption it is projected that in 2018 only about 1,800 estates will owe federal estate tax. However, for those of us who expect to be around on January 1, 2026, the lower exemption is more relevant for estate planning purposes.
Rate Remains Unchanged
The Act maintains the 40% rate on taxable gifts, taxable estates and non-exempt generation-skipping transfers to grandchildren and other “skip persons.” Many gifting techniques which generate estate tax savings reduce the overall tax by the difference between the estate tax rate and – because of the step-up in basis at death — the capital gains rate. The maximum rate for most kinds of capital gain remains 20% so the net tax savings from these gifting techniques remains a meaningful 20%.
Under the concept of “portability” — which first became a component of the federal estate and gift tax law in 2010 — any portion of the exemption which the first spouse to die, or his or her estate, does not consume, can be added to the exemption of the surviving spouse to reduce or eliminate his or her estate tax, as long as the personal representative of the estate of the first spouse to die files a federal estate tax return and does not elect-out of portability. Portability remains in effect under current law, but it is unclear whether, if the first spouse dies before 2026 and his or her personal representative files a federal estate tax return, how much of the exemption will be “portable” to the estate of the surviving spouse if he or she dies after 2025. For example, it may be that the pre-2018 exemption amount will be “portable” but the 2018 to 2025 exemption amount will not. We expect the IRS to issue regulations to clarify this issue.
Possible Claw Back of 2018 – 2025 Taxable Gifts
Some clients will take advantage of the temporary increase in the exemption by making large gifts to individuals or trusts between 2018 and 2025. While most commentators believe that for donors who make large gifts between 2018 and 2025 and who die after 2025 those gifts will not be “clawed-back” to the donor’s taxable estate and made subject to federal estate tax, we will not know for sure until the IRS issues regulations.
Step-up in Basis Remains
The Act does not change the longstanding rule that all assets (other than retirement accounts and other items of “income in respect of a decedent”) receive a step-up in basis at death. This means that pre-death appreciation is disregarded for income tax purposes when assets are sold by an estate or its beneficiaries. Some observers thought that as a trade-off for a doubling of the exemption the step-up would be eliminated or not remain available for all assets, but that did not occur.
There is a lot to think about (and figure out) with these changes to the estate and gift tax laws and there are a variety of planning opportunities the Act presents.