On December 20, 2017, both the House and Senate passed the Tax Cuts and Jobs Act. The bill, which was previously passed by both chambers in different versions, was consolidated into a single bill by a Conference Committee to work out the differences between the chambers’ respective bills. President Trump signed the bill into law on December 22, 2017.
The long awaited tax bill was heavily negotiated by Republican lawmakers over the past few weeks and contains significant changes to the individual income, corporate, business and estate tax regimes. The original bill that passed the House doubled the estate tax exemption from $5.6 million for individuals in 2018 ($11.2 million for married couples) to $11.2 million for individuals ($22.4 million for married couples), with a full repeal scheduled to take effect in 2025. The original Senate bill called for a doubling of the estate tax exemption without any full repeal. The final bill that passed both chambers doubles the exemption for years 2018 to 2025, followed by a drop back to current exemption levels in 2026. There will be no repeal of the estate tax and the exemption will continue to be indexed for inflation. The final change to revert back to current levels in 2026 was made to satisfy Senate parliamentary restrictions to ensure that the overall tax bill fell within budgetary limitations, in order to pass the bill by a simple majority.
The new tax law makes no change to existing law which allows a “step-up” in basis of assets held by an individual at death. The step-up in basis allows the beneficiaries of an estate to take each asset of the estate with a fair market value basis, rather than carrying the existing basis over, which ensures that there will be no income tax on capital gains accrued prior to an individual’s death.
The estate and gift tax exemption is in effect a single exemption that can be used to offset the amount of gifts individuals make during life or upon death. There is a 40% tax on the amount of gifts or bequests made in excess of the exemption to beneficiaries other than charities or spouses. There is also an additional transfer tax on gifts or bequests made to grandchildren or more remote descendants, known as the generation-skipping transfer tax, with a separate exemption amount that matches that of the estate tax and a flat tax rate of 40% on transfers to such beneficiaries that exceed the exemption.
It is unclear how the estate and gift tax regime will be imposed beginning in 2026 when the exemption drops back to current levels. The law calls for the Treasury Department to promulgate regulations to account for the difference between the increased exemption prior to 2026 and the reduced exemption beginning in 2026. If regulations are not imposed, theoretically an individual can make $11.2 million of gifts during life without being subject to gift tax, then upon death on January 1, 2026 with no assets, he or she would be subject to a multi-million dollar estate tax liability.
A likely outcome of new regulations will be to increase the exemption in 2026 by the amount of gifts made from the excess exemption during the period from 2018 to 2025, in order to ensure that there is no penalty for making gifts within the present exemption level. Such rules would incentivize the making of lifetime gifts during this period of at least the excess exemption amount (i.e., $5.6 million) for those with assets in excess of $11 million ($22 million for a married couple).
Should Democrats retake control of Congress and the White House in the coming years, there is a chance that the increased exemption could fall back to current levels even earlier than 2026.
No matter what regulations are ultimately imposed or who controls Congress and the White House in the future, the passage of this tax bill ensures that an estate tax will continue to exist, and estate tax planning is necessary now more than ever. The attorneys in the Private Client Services Group at Duane Morris are prepared to assist you with this vital process in 2018.