The Tax Cuts and Jobs Act, which became effective on January 1, 2018, is considered the most significant overhaul of the U.S. Tax Code since 1986. The changes will have a profound impact on individuals, trusts, estates, and businesses in a variety of ways.
Generally, the new tax law alters individual income taxation and estate planning concepts, reduces corporate income taxes, and introduces a new method of taxing the earnings from certain pass-through entities. It also significantly impacts taxation for multi-national entities.
The purpose of this article is to consider the impact of the new tax law solely upon estate planning.
At the outset, it is important to understand that the provisions relating to estate taxation expire on December 31, 2025. The “covered years” for estate planning purposes are 2018 through 2025. Thereafter, the exemptions noted in the next paragraph sunset after 2025 and return to the 2017 amounts, as adjusted for inflation. Additionally, it is possible and perhaps probable that such exemptions may be reduced should there be a change in the administration or the composition of Congress before the end of the covered years.
There had been a great deal of attention paid to the possible repeal of the federal estate and gift tax law. However, the new tax law does not provide for repeal, but does double the amount a person may transfer free of federal estate, gift, and generation skipping transfer taxes either by gift or at death, making federal transfer taxes irrelevant for all but the very wealthiest Americans.
The exemptions for the covered years for these three types of transfer taxes are now doubled to approximately $11.2 million. This means that a married couple now has the use of $22.4 million in transfer tax exemption.
The tax rate on transfers in excess of the exemptions will remain at forty percent (40%). The gift tax annual exclusion has been increased from $14,000 to $15,000 per donee. The tax basis of assets passing at death will continue to be adjusted to the date of death value of the asset.
Additionally, and very importantly for New York residents, New York State estate tax law is not correlated with the new federal tax law, and remains a significant consideration for many New Yorkers. For example, if a person had an $11 million taxable estate, it would be exempt under the current federal law, but would incur approximately $1.25 million of New York estate tax. Therefore, planning to reduce the New York estate tax will still be an important consideration for many New Yorkers.
What happens if the gift tax exemption is reduced by Congress to say $6 million or that is the amount provided by the sunset provision, and an individual has made gifts in excess of that amount?. Will the gifts over the $6 million figure be subject to gift tax at forty percent (40%)? The answer appears to be no. Although no regulations have yet been issued on this point, the intent of the Tax Act is that taxpayers can rely upon the larger amounts in doing their planning without fear that there will be in effect a retroactive tax on gifts.
Accordingly, in appropriate circumstances it makes sense for individuals to make large gifts in the near future to get the amount of those gifts out of their possible taxable estate, given the absence of a claw back provision.
It also makes sense to review existing estate planning techniques to try to increase the basis of assets already transferred, where the basis would otherwise be limited to the basis in the hands of the donor or testator. For example, it may be possible to amend the provisions of certain marital deduction trusts and generation skipping trusts so that the property is part of the beneficiary’s taxable estate. Given the increased estate tax exemption, there would be no estate tax generated, but the assets would receive a new basis equal to the assets’ value at the beneficiary’s date of death.
Also, if an individual had established a Qualified Personal Residence Trust and the requisite time period had passed such that ownership passed to his children although he remained in the residence, it might make sense for him not to pay a fair market rental to his children so that the value of the property would be includable in his taxable estate. Again, given the larger exemption amounts, there would be no estate tax, but his children would receive a basis step up in the property equal to the value at his date of death.
There are certain non-tax related considerations which should be examined in light of the Tax Act. For example, many individuals have purchased life insurance and placed the ownership of the insurance into an irrevocable life insurance trust. This had the dual objective of providing liquidity for estate taxes and removing the policy proceeds from the same estate taxes. It may well be that individuals should examine those policies to determine whether they are still necessary for the intended purpose and, if not, whether they still make sense as an investment vehicle. Also, if the dispositive provisions of the life insurance trust no longer make sense, there may be methods of dissolving the life insurance trust and getting the policy itself back in the hands of the insured so that he can make alternate arrangements with the proceeds at his death.
Additionally, a number of family limited partnerships or limited liability companies were established primarily for the purpose of obtaining valuation discounts for estate tax purposes at the death of the senior generation. With the increased exemption, it makes sense to review the necessity of these entities and consider their liquidation and dissolution if they do not serve purposes other than tax purposes.
Given the transfer tax exemption increases, many clients will be satisfied with simple Wills leaving all of their property to a spouse and leaving all of the property outright to the children when both spouses are deceased. This may well be sufficient for many people, but it is important not to forget the disadvantages of this type of planning. Many spouses have had no experience with financial management and would find it a burden. Also, the surviving spouse may remarry and the marital property may wind up in the hands of another spouse or children from a different marriage. Also, a trust can protect assets from the claims of third party creditors of a beneficiary, such as the plaintiff in a lawsuit or a spouse in a failed marriage or the government in a Medicaid context. Additionally, children who have not fully matured may rapidly dissipate an outright inheritance, or that inheritance could provide a disincentive for such children.
Although the new Tax Act may make a good deal of planning simpler, keep in mind that Powers of Attorney, Health Care Proxies and Living Wills will still be necessary.
It is also necessary that retirement plans (which are often a client’s major asset) have the proper beneficiary designations. Also, trusts can be established to protect disabled persons among other advantages of proper planning.
Of particular importance are the review of traditional estate tax reduction Wills, where the exempt amount is placed in a trust typically for the benefit of spouse and/ or children, and any amount in excess of the tax exempt amount passes outright to the spouse. With the new higher exemptions, it could be that all of an individual’s property passes into a trust for no good reason. Therefore, these plans in particular must be examined.
In summary, the new Tax Act provides very important transfer tax relief for transfers made or deaths occurring during the covered years. Congress may change the exemptions, and the Act sunsets after December 31, 2025. During the covered years, estate planning should be reviewed to see whether it still makes sense given the tax law changes, and for many people planning changes for tax and non-tax reasons will be in order.
Article written by: Partner, Michael F. Buckley, Esq.