The tax bill recently passed by the U.S. Congress and signed by President Trump retains the gift and estate tax, but substantially curtails its reach. The new tax legislation represents a dramatic change to our transfer tax system and may afford wealthier Americans a reduction in estate and gift taxes (at least for a time—see below) and/or the opportunity to complete some advantageous tax planning.
While under the new law the estate/gift/generation-skipping transfer (GST) tax rates remain unchanged at 40 percent, starting in 2018 the amounts exempted from federal estate tax, gift tax and GST tax have all been doubled, from $5.6 million per person (indexed for inflation) to $11.2 million per person (indexed for inflation).
Those dramatic increases in the gift/estate/GST tax exemptions will no doubt yield significant transfer tax savings for some Americans who make large gifts and for others who stand to inherit from very large estates…but there is a catch. Under the new legislation, these changes, while dramatic, are not permanent. Absent further action by Congress, these enhanced exemption amounts will all expire at the end of 2025. In 2026, without further legislation, the enhanced exemption amounts will revert to 2017 law with an exemption amount of $5.6 million per person (indexed for inflation).
Very significantly, the step-up in basis for assets transferred at death (the increase in an asset's tax basis from its cost to its fair market value on the date of the owner's death) continues under the new law. Many commentators had suggested that a repeal of this step-up in basis (or at least a limitation on the overall amount of increase upon death) would be included in the tax legislation as a way to pay for at least a portion of the revenue lost as a result of increased exemption amounts, but that did not occur. The increased exemptions ($11.2 million per person and potentially $22.4 million for a married couple) obviously reduce the number of people who may face the prospect of paying estate or gift tax on testamentary or lifetime transfers that occur in the 2018-2025 time period. But, given the current sunset of the changes beginning in 2026, there continues to be uncertainty as to whether at some point in the next few years Congress will:
- Act to allow the new exemption amounts (or perhaps different amounts) to continue in 2026 and beyond
- Repeal the estate tax entirely (consistent with the approach that had been taken in the initial House tax bill)
- Through inaction, allow the exemptions to revert to 2017 levels effective Jan. 1, 2026
Capture Benefits, Avoid Consequences
In light of that uncertainty, taxpayers should review their estate plans and current gifting strategies/opportunities in order to make sure they capture any desired benefits and avoid any negative consequences.
For example, many taxpayers have language in their current estate plans that is intended to take advantage of the current exemption amounts. However, that language is typically structured as a formula so that it will adjust automatically to changes in the law. Taxpayers will want to make sure that the results under their plans are still appropriate in light of the new increased exemption amounts. Depending on the size of a taxpayer's estate, his or her intent, and the current terms of the estate plan, the doubling of the exemption amounts could have the unintended consequence of passing more (or less) of a taxpayer's wealth than is otherwise intended to his or her spouse, children, grandchildren, more remote descendants, and/or to charity.
Consider Alternate Provisions
With continuing uncertainty as to future tax law, it may be advisable for taxpayers to implement wills or trusts containing alternate provisions that provide flexible tax planning based upon the estate tax exemption amount actually in effect at death.
Wealthy taxpayers may also want to consider a more aggressive gifting strategy to take advantage of these exemptions while they last. Taxpayers often consider lifetime gifts with the goal of reducing or eliminating the estate tax that would otherwise be incurred at death, and the larger gift tax exemption may make that approach even better.
However, the income tax basis of assets to be gifted must also be taken into account. The income tax basis of any assets gifted during lifetime carries over to the recipient of the gift, and if appreciated assets are transferred to a recipient, he or she will incur the same capital gains tax result when he or she sells the assets that the person making the gift (if living at the time of sale) would have experienced.
As noted above, the new tax law preserves the potential full step-up in basis that is available upon the death of an individual, so in some cases it may make more sense to transfer the asset at death (to allow the recipient to avoid incurring any income tax liability related to the future disposition of the asset) rather than through a gift.
On the flip side, the increase in the lifetime gift tax exemption amount may only be temporary, so this new legislation may provide a temporary window of opportunity for those who can afford to make very large lifetime gifts to family members or others without gift tax. While the gifted property would have the gift giver's income tax basis, a current gift would allow any future appreciation in the value of the assets or income from the asset to shift to the recipient free of gift or estate tax and, if the gift is large enough, the gift giver may be able to lock-in the use of these larger exemptions even if they later revert to 2017 levels.
Planning Is Key
Planning in this environment is going to be challenging, with continuing uncertainty as to whether the estate tax will be imposed at a person’s death (because the estate tax may be repealed or because exemptions may increase or decrease) and because the income tax consequences of making a current gift versus planning for a transfer on death are so different. One thing is certain: a failure to plan in this changing environment only increases the likelihood of unintended consequences.