On Dec. 22, 2017, President Trump signed into law what is commonly known as the Tax Reform and Jobs Act of 2017 (2017 Act). As explained in more detail below, the 2017 Act increased the estate, gift, and generation-skipping transfer (GST) tax exemptions. This legislation expires at the end of 2025 and the tax laws will revert to where they stood prior to the 2017 Act unless Congress makes additional changes before then.
Gift, estate, and GST tax laws for 2018 through 2025. The 2017 Act increased the estate, gift, and GST tax exemptions to $10 million per person, indexed for inflation (projected to be $11.18 million per individual in 2018, or $22.36 million for married couples). You can now make lifetime gifts up to a maximum of $11.18 million without incurring a gift tax. Any gifts made during your lifetime in excess of the annual exclusion ($15,000 in 2018) reduce the estate tax exemption available at death. If you make no taxable gifts during your lifetime, then you will have the full $11.18 million estate tax exemption available at death. The GST exemption now allows you to shield $11.18 million of gifts to grandchildren from the GST tax. Unless Congress acts sooner, the 2017 Act will be automatically repealed on Jan. 1, 2026, reverting to $5 million exemptions for estate, gift, and GST tax (to be adjusted for inflation).
Review your estate plan. In light of these increased exemptions, it is important to review your estate plan. Many wills and trusts include formula clauses that leave a certain amount of assets to individuals based on the exemption amount available at the time of death. With the change in exemptions, these formulas could drastically change your estate plan as you may not have anticipated, and your documents may even unintentionally disinherit someone.
An unprecedented opportunity to make gifts. The gift tax exemption is significantly larger than it has ever been, and larger that it was ever expected to be. Therefore, this may be the perfect time to make gifts. If you have a large enough estate that you expect to be paying an estate tax when you die, then it is more tax efficient to use the gift tax exemption while you are alive as opposed to using estate tax exemption when you die. The benefit of a lifetime gift is that all of the future income and appreciation on the gifted assets passes estate tax-free to the donee. For example, if you gave $11.18 million to a trust for your children in 2018 and lived another 20 years, then you would exclude $25 million (assuming income taxes are paid by you as grantor) more from your taxable estate than if you had waited until your death to use the $11.18 million exemption (assuming 6 percent annual growth). With a 40 percent estate tax rate, this excluded $25 million results in an estate tax savings of $10 million. However, it is also especially important to evaluate and consider the potential income tax impact of gifting certain assets.
Discount planning. If you expect to pay estate taxes, making gifts of discounted assets (partial interests in partnerships, limited liability companies, and real estate) will continue to be important. IRS regulations meant to eliminate discount planning were never implemented, so this continues to be an effective planning tool.
Clawback. The 2017 Act directs Treasury to create regulations to address any difference in the exemption amount at the time of a gift and at the time of death. Some refer to this as a “clawback.” For example, if you make an $11.18 million gift in 2018 and die in 2026 when the gift tax exemption is $5.5 million and estate tax rate is 40 percent, your estate may owe over $2 million in estate taxes at your death due solely to the prior gift. It appears this is not what Congress intended and hopefully the regulations will clarify this.
Missouri estate tax laws. Missouri’s estate tax is equal to the federal credit for state estate taxes paid (referred to as “pick-up tax”). As there is currently no federal credit for state estate taxes (there is only a deduction), there will continue to be no Missouri estate tax.
Illinois estate tax laws. Illinois has an estate tax with a $4 million exemption. If a married couple uses a traditional credit shelter trust to take advantage of the full $11.18 million federal estate tax exemption in 2018, then, assuming the trust is fully funded at the death of the first spouse, there will be an Illinois estate tax in excess of $1 million. However, Illinois law allows your executor to make a special election, called a “QTIP” election, to defer the Illinois estate tax on any portion of your estate passing to a credit shelter trust for a surviving spouse so long as the credit shelter trust contains certain provisions. This would essentially create a separate QTIP trust for that portion of your estate that exceeds the $4 million exemption. As a result, instead of being subject to Illinois estate tax at the first spouse’s death, the value of the QTIP trust will be subject to such tax at the surviving spouse’s death. Therefore, if you wish to take advantage of this Illinois QTIP election, it is important to make sure that the trust terms will meet the requirements.
Undoing unnecessary planning. With the increased exemption, estate tax planning may no longer be needed for some clients. An estate plan that formerly provided estate tax benefits may now have negative income tax consequences. Your estate plan should be reviewed to determine if it should be altered or simplified. This may include terminating or modifying irrevocable trusts or liquidating partnerships or LLCs.
Estate planning continues to be important. Even with the increased exemptions, it will be important to plan to protect inheritances from creditors and divorce claims. Income tax planning for trusts will continue to play an important role due to the compressed trust income tax brackets. Avoiding state income taxes for trusts is also an overlooked area that should be reviewed.
Partnership audit rules. New partnership audit rules went into effect in 2018. These rules were not changed by the 2017 Act. All existing partnership agreements and LLC operating agreements (for LLCs that are taxed as partnerships) will need to be reviewed in 2018 to determine if changes need to be made based on these new laws.
Dividing assets among trusts. There is now a $10,000 limitation on the annual state and local tax deduction, which also applies to trusts. Consider dividing assets among several trusts to more fully utilize the deduction.
Business entity planning. Other areas that will be important in coming years are evaluating the most tax efficient business entity structure (S corporation, C corporation, partnership), and deciding whether it saves income taxes to be an independent contractor versus a W-2 employee based on the new 20 percent deduction for pass-through entities and sole proprietorships.
Flexibility. The key to estate planning in 2018 and beyond is drafting for flexibility, as we never know what the future brings. Your documents should contain provisions that account for the possibility of changes in the law, changes in your wealth, and changes in family circumstances. Also, consider whether including a “trust protector” in your estate plan could provide additional flexibility.