With the passage of the Tax Cuts and Jobs Act (Reconciliation Act of 2017) on December 19, 2017 (the Act), Congress provided increased, albeit temporary, relief to taxpayers who otherwise might be subject to federal transfer taxes (i.e., Estate, Gift and Generation-Skipping Transfer Taxes). The Act provides significant planning opportunities for those in a position to transfer wealth to lower generations without incurring gift or GST tax. However, it affects every person’s estate plan in some way, and we strongly recommend that individuals review their current estate plans in consultation with their professional advisors to confirm that their wishes will be carried out under the new law. This memo highlights some of the more noteworthy changes in the new law that will affect your lifetime and testamentary estate planning.
Estate, Gift and Generation-Skipping Transfer (GST) Taxes.
While stopping short of total repeal, the Act doubled the current exemption from estate, gift and GST taxes. The new provisions are effective for taxable years 2018–2025 (i.e., eight years), provided that no additional changes are made to the law before that time. The Act increases each individual’s basic exemption amount for federal estate, gift and GST tax from $5 million to $10 million, indexed for inflation. The estate tax rate remains unchanged at 40% for estate assets that exceed an individual’s basic exclusion amount.
For the year 2018, the indexed exemption amount is $11.18 million per person ($22.36 million per couple). Under the Act, in 2026, all of the foregoing exemptions will revert back to $5 million per person, adjusted for inflation.
The annual gift tax exemption amount, which permits individuals to make annual gift transfers to any individual each year without incurring a gift tax, will increase slightly to approximately $15,000 for 2018 (from $14,000 in prior years).
The concept of “portability” of the estate tax exemption amount is retained, so if the exemption is not fully utilized for a married couple at the first spouse’s death, the survivor can retain any unused exemption of the first spouse and apply it at the survivor’s subsequent death. When and if the Act sunsets, however, it is not clear whether the entire ported amount would be retained or if it would be reduced to match the revised exemption amounts that take effect in 2025. To elect portability, the surviving spouse must file a federal estate tax return, which the spouse might otherwise be disinclined to do.
While the federal estate tax now only affects taxpayers with assets valued above $11.18 million, many more taxpayers pay state inheritance or estate taxes. While California currently imposes no estate or inheritance tax, if you own property in other jurisdictions, your estate or your heirs may be subject to the state death tax levied in those states beginning at much lower exemption levels. Top state estate tax rates are typically around 16%, and for inheritance tax states, the tax can apply to the first dollar of assets.
Impact on Planning and Opportunities.
- Testamentary Planning. Depending on the terms of your current estate planning documents, the increased exemption amounts could drastically alter the disposition of your estate. If your documents contain formula bequests that were based on pre-2018 exemption amounts, the resulting property transfers may not match your original expectations.
- Gifting. Since the $11.18 million exemption will revert to prior levels in 2026 (or possibly sooner), we recommend that you begin the planning process for substantial lifetime gifts as soon as possible. This will maximize use of the exemptions before they expire. In addition, the transfers could be structured to shift income and appreciation on gifted assets out of your estate. The Act authorizes the Treasury to issue regulations as necessary to address any difference in the exemption amount at the time the gift is made and at the time of death. This is to deal with the possibility of a “clawback” (i.e., a prior gift that was covered by the gift tax exemption at the time of the gift might result in estate tax if the estate tax exemption amount has decreased by the time of the donor’s death, thus resulting in a “clawback” of the gift for estate tax purposes).
- Basis Adjustment Planning. For estates valued at well under the new exemption amounts, incorporating flexibility into plans by causing trust assets to be included in the gross estate of a trust beneficiary who has excess estate tax exemption will be important to permit an income tax basis adjustment at the beneficiary’s death. While in the past we have recommended moving assets down to lower generations, in some cases it may now make sense to actually “gift up” or “gift across,” so that an elderly relative or other beneficiary will have enough property includable in his or her estate to fully utilize his or her own increased estate tax exemptions while providing an income tax basis step-up on such assets upon the individual’s death.
- GST Tax Planning. We often recommend the use of dynastic trusts to take advantage of the GST exemption. Since the increased exemption on the GST tax is temporary however, it makes sense to take advantage of dynasty GST trusts to use the new $11.18 million exemption while you can. Such trusts might allow clients to pass assets over successive generations without the imposition of any future transfer tax, and, if sited in other states, could have limited income tax exposure and increased creditor protection, and could exist perpetually for succeeding generations free of transfer tax.
While the Act is slated to be in place for the next eight years, given the current political situation, it is entirely possible that the tax laws may again be revised prior to 2026. For that reason, and because your plan may no longer contain the optimal planning provisions, we recommend that you review your estate planning goals and objectives sooner rather than later.
While a minority of estates in the United States fall above the increased exemption amounts, if the value of your estate is well below the revised exemption, this doesn’t mean you don’t need to do estate planning. In addition to correcting your plan so that it is consistent with the new law, there are still many non-tax reasons to plan, including the creation of solid business succession plans, the naming of guardians for minor children, creditor protection through the use of trusts, and appointing agents to act on your behalf under a financial power of attorney and/or advance healthcare directive in the event of your incapacity.