Written by: Ted Troland
The Tax Cuts and Jobs Act of 2017 (TCJA) made changes to the law that will have a significant effect on estate planning, at least over the next several years.
Most importantly, the amount that an individual can shelter from federal estate and gift taxes (and generation-skipping taxes) was effectively doubled. The new exemption for 2018, which was to be $5.6 million, is now $11.18 million, or $23.36 million for a married couple. This increased shelter amount, along with annual inflation adjustments, is due to continue until December 31, 2025. On January 1, 2026, the shelter is scheduled to revert back to $5.6 million, perhaps with some allowance for inflation that may occur in the intervening years.
What to do
Individuals and couples with significant wealth should consider taking steps in 2018 and soon thereafter that will take advantage of the increased shelter amount. By using some or all of the increased exemption amount to make additional tax-free lifetime gifts (the exemption covers gifts as well as estates), the transferred assets – together with any future appreciation in value – can be shielded from estate and gift taxation.
When to do it
Readers may recall the last-minute and highly partisan manner in which TCJA was passed. There is a substantial risk that the inflation-adjusted $11.18 million per person shelter may, in fact, not remain in effect until 2026. What happens if you make a gift now in excess of a smaller exemption in effect when you die? It seems pretty clear that there will be no “clawback,” meaning that transactions effected during a period of increased exemption will not be affected by later changes in the law. Congress has directed that the IRS to issue regulations providing that steps taken while the new liberal regime is in effect will not be undone by later legislative changes.
Income tax caveat
Bear in mind that lifetime gifts, unlike assets transferred at death, are not entitled to a stepped-up basis and can thus increase income taxes on any gain realized by the recipients should they sell a gifted asset. A taxpayer may prefer to retain the ability to unwind a transfer if it later becomes unnecessary or seemingly ill-advised. For example, a person can gift or sell assets to a trust and retain the ability to substitute assets (which ability does not prevent there being a completed gift), allowing the return of low-basis assets back into the estate before death.
Note the change in emphasis from previous years in the estate tax-income tax equation. Practitioners used to use sophisticated devices to reduce the tax value of transferred assets. It now turns out these assets may have escaped estate tax because of TCJA, but will have a low income tax basis to the donee.
It almost certainly bears looking at your existing estate planning documents. For example, you may wish to check to see if a power of attorney allows your agent to make gifts of your property should you be incapacitated. It might well be worth granting such a power to a trusted individual to allow the pre-mortem transfer of low basis assets to family members so that they will obtain a step-up in basis at your death.
Many wills and trusts were drafted when the transfer tax exemption was substantially lower, perhaps $600,000. Many of those documents contained a two trust arrangement, with both trusts providing for a surviving spouse but with language for one trust designed to keep the assets out of the survivor’s estate. These may no longer be necessary since we have had for a few years the feature of “portability” of the exemption between spouses. Thus, if everything is left outright to a surviving spouse, and the decedent’s exemption is not exhausted, it is no longer the case that the decedent’s exemption is necessarily wasted. Under portability, the surviving spouse’s estate can avail itself not only of its own exemption but of the unused exemption of the first spouse to die.
Of course, as always, there remain traps for the unwary. If the surviving spouse remarries, he or she will no longer have access to the exemption of the first to die, but only that of the new spouse (this should make pre-nuptial agreements more interesting). Further, to take advantage of the portability feature, portability must be elected on an estate tax return filed for the estate of the first spouse to die, even if there is no tax owing at all. If a return is not filed within the specified statutory period, i.e., one year from death with a six-month extension if requested, the unused exemption of the first to die will evaporate. Finally, while the generation-skipping (GST) exemption increased with that of the estate and gift tax, a deceased spouse’s unused GST exemption is not portable and does not carry over to the estate of the surviving spouse.
So, then, a review of your planning is certainly in order. First, it is likely that your documents can be greatly simplified, with hitherto necessary trusts now being extraneous. We have recently revised plans with wills and trusts in excess of twenty pages (necessitated by prior tax law) reduced to two or three pages, even with clients of substantial means.
Secondly, there is a window of opportunity to make gifts over the next few years that will substantially reduce or eliminate an estate tax that would otherwise be imposed, at least after the death of the second spouse to die.