On December 22nd, 2017, President Trump signed the Tax Cuts & Jobs Act (“the Act”) into law. The bill passed Congress through the reconciliation process, thereby avoiding filibuster in the Senate but requiring revenue neutrality over a 10-year period. As a result, many of the key provisions are scheduled to sunset at the end of 2025, assuming they are not sooner reversed or otherwise changed by a new administration or Congressional leadership. While the Act represents sweeping tax reform with significant changes to income taxation for individuals and businesses, the focus of this article is on the Act’s impact to estate planning.
Under the Act, gift, generation-skipping transfer (GST) and estate exemptions doubled. Starting in 2018, each person may transfer $11.2 million free of transfer tax. Married couples may effectively transfer $22.4 million due to portability of exemptions between spouses. Exemption amounts will adjust annually for inflation. The annual gift exclusion for 2018 is $15,000 per year per donee, and the unlimited education and medical exclusions remain so long as payments are rendered directly to the provider.
To the surprise of many, stepped-up basis remains under the Act. This means the tax basis of assets transferred as a result of death are stepped up to the asset value as of the date of death resulting in reduced future capital gains liability for beneficiaries. Basis step-up represents a significant planning opportunity in itself. For example, assets in a traditional credit shelter trust of the first spouse to die will not receive a second step-up upon the death of the second spouse. Reworking an existing estate plan or adding provisions to an existing plan may provide the opportunity for an additional step up at the second death. With fewer estates subject to the estate tax, basis planning may become a greater priority for many. Note that assets gifted during life do not receive a step-up; rather, gifted assets have carryover basis, meaning the gift recipient maintains the donor’s basis.
It is critical that clients review existing estate planning in light of the higher exemption amounts. Plans often use formulas based on the exemption amount to determine trust funding levels. As you might imagine, this could result in inadvertently over or under funding trusts for a certain class of beneficiaries. For example, some plans fund trusts for the benefit of grandchildren to the extent of the GST exemption. With the much higher exemption under the Act, adjusting for the new exemption amount could result in little or no residual funding for the surviving spouse.
It is estimated that fewer than 1000 estate tax returns will be filed per year under the Act. As such, non-tax objectives such as asset protection, succession and legacy planning may be more relevant. Reviewing your plan in the context of the Act is also an opportune time to ensure designated fiduciaries (executors, trustees, guardians) are still consistent with your wishes.
For some, particularly couples with combined estates under $11.2 million and without extenuating circumstances, the new law may provide opportunities for simplification if previous planning had primarily been tax-motivated. For example, rather than automatically funding trusts upon the first death, a client may instead wish to leave everything to the surviving spouse with the ability for them to disclaim into a trust. Disclaimer trusts allow the surviving spouse (in conjunction with an attorney and other advisors) to determine whether to fund a credit shelter trust when their spouse passes based on circumstances at the time of death. If the trust is not needed, it does not have to be funded; but, if it makes sense to fund the trust, the spouse can disclaim their inheritance into the trust. Nonetheless, the benefits of simplification should be weighted against the more protective nature of traditional trust planning.
For clients with estates that were taxable under prior law (over the $11.2MM married threshold and $5 million for single clients), the Act provides a window of valuable planning opportunity. The Act’s higher exemption levels translate to tax savings of 40% of the value of an estate between $11.2 million and $22.4 million per couple – for a $22.4 million estate, that’s an almost $4.5 million gift from the government. . .but only to the extent assets are transferred while the exemptions remain at this level. Since it is hard to predict when we will die, it is arguably prudent to use the higher exemptions now via lifetime transfers. Another benefit of lifetime transfers is that subsequent growth of assets transferred occurs outside of your estate. To the extent leverage can be infused into the planning, e.g., through sale of assets to trusts or transfer of discounted assets, the tax savings can be amplified. If you are eager to capitalize on the higher exemption amounts but uncomfortable parting with significant assets, non-reciprocal spousal limited access trusts, aka SLATs, (or self-settled domestic asset protection trusts, aka DAPTs) for single clients, might be advisable. These strategies are too complex to cover in a couple of sentences but may warrant further exploration with your advisor.
Regardless of your wealth level, as existing estate plans are reviewed, it is important to weigh the pros and cons of prior planning. Just because a strategy may no longer seem relevant, formalities such as required payments between entities or administrative procedures cannot be ignored. Many clients may be wondering if their life insurance trusts are still necessary; we recommend a thorough evaluation of available options before acting. For example, perhaps the policy could be modified to a paid-up policy, or a large gift could be made to the trust to facilitate future maintenance of the policy while eliminating the need for future annual Crummey notices; or alternatively, the policy could be terminated with cash surrender value distributed among beneficiaries. Before deciding to unwind strategies that may be in place, consider the potential for laws to change again.
A couple of final thoughts – with higher exemptions, it may seem unnecessary to file an estate tax return for a nontaxable estate. However, a return must be filed to preserve the unused exemption of a deceased spouse. This will be particularly critical if exemption amounts decrease in the future. And regarding incapacity planning (powers of attorney, revocable trusts) for higher net worth clients, it might be advisable to allow your agent or trustee to make transfers up to the exemption amount to ensure maximum planning opportunities if you were to become incapacitated prior to a provision sunset.
Bottom line – it is prudent to review your estate planning in light of the new tax law. And, as with many things in life, flexibility is key.
The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you our your business.