As you probably know, the Tax Cut and Jobs Act of 2017 (the “Act”) was signed into law by President Trump on December 22, 2017. The Act made a wide variety of changes to the Internal Revenue Code, which affect most taxpayers in one way or another. This Client Alert highlights some important changes in the Act that may impact your estate planning.
The Act significantly increased the federal estate and gift tax applicable exclusion amounts and the generation-skipping tax exemption (collectively, the “Exemption Amounts”) from $5,600,000 as of December 31, 2017 to $11,180,000 as of January 1, 2018. The tax rate on transfers in excess of the Exemption Amounts remains at 40%. This means that a married couple, with proper planning, has the use of $22,360,000 in gift tax and estate tax applicable exclusion amounts, provided that certain actions are taken when the first spouse dies (the unused applicable exclusion amount of the first spouse to die still can be “ported” or transferred to the surviving spouse). The increased Exemption Amounts are scheduled to sunset as of January 1, 2026, at which time those amounts are scheduled to revert back to the 2011 amounts of $5,000,000 each, adjusted for inflation.
Importantly, there is no change to the adjustment to the federal income tax basis of certain assets owned at death (commonly referred to as the “basis step-up”).
The gift tax annual exclusion continues to be available, and it has increased from $14,000 per recipient per year in 2017 to $15,000 per recipient per year in 2018.
There are some clients who should review (and possibly revise) their estate plan in light of the very significant increase in the amounts that can be transferred free of estate, gift and generation-skipping tax. First and foremost, some of our clients have estate plans that make transfers at death to certain individuals or transfers based on the size of the estate tax applicable exclusion amount or the generation-skipping tax exemption; those clients should consider revisiting those plans.
Disposition based on estate tax applicable exclusion amount. For some couples, the estate plan may envision passing an amount equal to the available estate tax applicable exclusion amount directly to their children or other beneficiaries, and not to the surviving spouse, or including children or other individuals with the spouse as beneficiaries of a so-called “Family Trust” or “Bypass Trust” holding the applicable exclusion amount. Such plans may now pass significantly more assets in that manner, and in some cases there may no longer be a tax reason for doing so. It is important to revisit these plans to make sure that they reflect the couple’s intent.
Disposition based on generation-skipping tax exemption. In some cases, an estate plan may envision an allocation of assets among classes of beneficiaries (for example, children and grandchildren), or may pass such assets to beneficiaries in trust versus outright, based on the amount of the generation-skipping tax exemption. Based on the higher exemption amounts, such plans may now pass significantly more assets to grandchildren or reduce the amount of assets passing outright to beneficiaries. It is important to revisit these plans.
For some clients with very large estates, the increase in the federal gift tax applicable exclusion amount to $11,180,000 may make significant lifetime gifts an attractive planning opportunity. This opportunity involves a delicate balancing of estate tax and income tax considerations. An asset that is gratuitously transferred during the donor’s lifetime carries with it the donor’s cost basis rather than the stepped-up income tax basis that the asset would receive if held by the donor at death and transferred at that time. Making gifts to an irrevocable trust that contains mechanisms to trigger basis step-up and estate tax inclusion, or making other forms of gifts, may mitigate some of these concerns.
If you are the trustee or a beneficiary of a trust holding significantly appreciated assets, the increased estate tax applicable exclusion amount also may present an opportunity to trigger basis step-up and estate tax inclusion. In some cases, it may be more beneficial from an income tax perspective to have assets included in the estate of the primary beneficiary to achieve a step-up in basis. For example, trusts funded for a surviving spouse when the applicable exclusion amount was much lower, such as a residuary trust (or a Family Trust or Bypass Trust) should now be reexamined. The top marginal income tax bracket for a trust (with income above $12,500) is now 37%, plus the 3.8% surtax on net investment income. The capital gain tax rate remains at 20% for trusts in the highest income tax bracket (with income above $12,500), plus the 3.8% surtax on net investment income. In other instances, it may make sense to terminate an old trust.
Some clients will ask if it is still necessary to include trusts in their estate planning if they are below the new Exemption Amounts. First, we note that the current increased Exemption Amounts are scheduled to revert to their previous levels at the end of 2025 – if not sooner, if a new Congress enacts different legislation. There are other considerations in estate planning that may still warrant the use of trusts, including the appropriate distribution of assets among different beneficiaries, planning for a special needs beneficiary, protecting your heirs from potential creditors and providing a form of asset management, to name a few. For many clients, trusts will continue to play an important role in their planning.
In light of these new developments and opportunities, it would be wise for many of our clients to review their estate planning documents and to update them to the extent desirable. At the same time, any significant changes in our clients’ family or financial goals can also be taken into account. If you would like to discuss the specific aspects of how the Act might affect your estate plan, please contact a member of our Trust, Estates, Fiduciaries and Family Business practice groups.