Seize the opportunity to make the most of your estate plan.
- As with any change in tax legislation, the Tax Cuts and Jobs Act of 2017 gives rise to valuable estate planning opportunities.
- The new tax law serves as a good reminder to review your estate plan to be sure that it is consistent with your current goals and is flexible to promote tax efficiency under today’s tax laws.
- In addition to estate tax planning, there are several other considerations that should always play a role in a strong estate plan.
In late 2017, both Houses of Congress and President Trump passed sweeping tax legislation impacting virtually all areas of federal tax law. As with any change in tax legislation, the Tax Cuts and Jobs Act of 2017 gives rise to valuable planning opportunities. Before exploring possible planning opportunities in the wake of the new tax law, it is important to understand what has changed and what has stayed the same.
Changes to tax law
The most impactful tax law change for estate planning purposes is the increase in the federal estate, gift, and generation-skipping transfer (GST) tax exemptions (collectively, the “federal exemption”) for each individual. Previously, the federal exemption was $5,000,000 per individual, indexed for inflation (in 2017, it was $5,490,000 and was set to increase to $5,600,000 in 2018). With the passage of the new tax law, the federal exemption has been doubled to $10,000,000 per individual, indexed for inflation. With the inflation calculation now tied to the chained consumer price index (CPI), the federal exemption is $11,180,000 per person in 2018. In addition to this change, as a result of inflation indexing, the annual gift tax exemption increased in 2018 to $15,000 per donor, per recipient. The top federal estate, gift, and GST tax rate remains at forty percent. Also unchanged are (i) portability of a deceased spouse’s unused exemption, (ii) stepped-up (or -down) basis of most assets included in a deceased individual’s estate, and (iii) valuation discounts for minority interests and lack of marketability.
The increase in the federal exemption provides a golden opportunity for individuals whose net worth is above the previous exemption to enhance their estate plans and preserve more wealth for their heirs. As a high-net-worth individual, it is critical to work with your advisors now to determine the new tax law’s impact on your own situation, and to take advantage of estate tax planning opportunities now that could mitigate the negative effects of federal estate, gift, and GST taxes on your estate. Many of the provisions of the new tax law are scheduled to sunset after December 31, 2025, at which time the prior provisions of the tax law would return if no further legislative action is taken. Further, given the nature of politics and fiscal realities, there always exists a very real possibility that the estate tax law will be modified prior to 2025.
As a high-net-worth individual, you may have felt prior to the new federal tax law that you had done all you could by transferring assets out of your estate and by using your entire federal exemption. Now, with the significantly increased federal exemption, you are afforded a fresh opportunity to shift more of your current wealth (and future growth on any transferred assets) to your heirs free of federal transfer taxes. The availability of minority interest and lack of marketability discounts for certain assets may allow you to further take advantage of the increased federal exemption and remove more value from your estate. For example, a dynasty trust established in a trust-friendly state, such as Delaware, is an excellent vehicle for such transfers. Also, by using a technique of selling appreciating assets to the trust in return for a promissory note, you can further leverage your available federal exemption to mitigate future federal estate taxes.
If you are an individual with net worth below the current exemption but closer to the previous exemption amount, aggressive planning may not be necessary. However, you should consider at the very least maximizing your use of the current generous federal exemption and freezing the value of your estate. You can freeze the value of your estate by transferring highly appreciating assets to your heirs (or into a trust for their benefit) now free from transfer tax, with the added benefit of removing the future growth (and resulting transfer taxes) from your estate. For married individuals who want to take advantage of the additional exemption but are hesitant to make a sizable irrevocable gift, you may consider forming non-reciprocal, spousal access trusts. In addition to mitigating estate inclusion, such trusts would also provide protection from creditors. Alternatively, individuals interested in creditor protection should consider self-settled domestic asset protection trusts, which if properly structured and implemented, can provide protection to the grantor from future creditors. Grantor Retained Annuity Trusts (GRATs) are still an appealing wealth transfer strategy for appreciating assets, particularly for individuals who want to gift the appreciation but retain the corpus of an asset. Such action will help avoid the negative impact of sunset of the current tax law or modification of the law to a much less generous exemption amount.
As mentioned above, the new tax law retains the concept of portability, allowing the unused estate and gift tax exemptions of a deceased spouse to be transferred to a surviving spouse, increasing the surviving spouse’s available exemption. However, portability only applies to the federal estate and gift tax exemptions and does not apply to the GST tax. It is important to be mindful of utilizing the increased GST tax exemption prior to the law sunsetting after 2025.
Other tax considerations
State estate and inheritance tax: It’s important to note that, despite the new federal tax law, many states currently still have an inheritance and/or estate tax. And, with increasing state fiscal challenges, there is no guarantee that one or more states will not pass legislation imposing more drastic state death tax laws. If you choose to utilize disclaimer trust provisions in your estate documents, you may want to consider language that funds a bypass trust with the state tax exemption amount at the first spouse’s death. QTIP trust planning may also be available at a state level depending on the specific state’s legislation. A QTIP trust offers flexibility in the allocation of your estate property while maximizing your tax saving benefits.
Income tax basis: Although an analysis of federal income taxes is beyond the scope of this article, it is worth noting that, while assets transferred at death generally enjoy a basis stepped up to the date of death value, assets gifted during life generally keep the basis of the donor. As such, the estate tax impact of any transfer of assets should be balanced against the future income tax effects of the sale of such assets. Planning techniques such as GRATs, ILITs, and substitution of assets may help you avoid over-planning for the federal estate tax at the expense of losing stepped-up basis of highly appreciated assets. For example, gifting a highly appreciated asset during life out of an estate that would not have otherwise exceeded the federal estate tax exemption will cause the recipient to recognize greater income tax gain on sale (due to the lower basis transferred with the gift) than if the recipient received the asset after the original owner’s death with a stepped-up basis.
Non-residents: It is also important to remember that the exclusion amount has not increased for individuals who are not United States persons. Proper estate planning for non-U.S. citizen spouses remains critical in order to prevent unanticipated estate taxes.
Charitable trusts: With the many changes in the federal income tax laws, you may find it advantageous to change your approach to philanthropy. Charitable trusts and Donor Advised Funds may provide the flexibility to allow you to gift in a more tax-efficient manner under the new tax laws.
Grantor trusts: You may find that in your state of residence, your individual income tax position (combined state and federal) has changed under the new tax laws. To the extent that such tax position is negatively affected by the new tax laws, you may want to revisit the merits of maintaining grantor trusts (which allow trust income to be reported by the grantor on a federal income tax return), and if appropriate, find value in turning off grantor trust status and allowing the trustee to shift income in the most efficient manner.
What is still important aside from estate tax concerns
Given the potentially destructive impact that estate taxes can have on illiquid assets, such as closely held business interests and real estate holdings, as well as the overall passage of wealth from one generation to the next, the importance of estate tax planning and the opportunities presented by the new tax law should not be ignored. However, in addition to estate tax planning, there are several other considerations that should always play a role in a strong estate plan.
Asset protection should always be a concern, regardless of your relative level of wealth or potential estate tax liability. Asset protection trusts with Delaware situs continue to afford the highest levels of protection and flexibility. The new federal tax law does not change this.
In addition, using life insurance to pay your estate tax liabilities might seem less relevant in light of the temporarily higher exemption levels. However, life insurance can provide another way to transfer wealth out of your estate in a tax-efficient manner. Life insurance can often be a source of liquidity for the estate, which is especially important for individuals with illiquid assets such as closely held business interests and real estate. Revisiting and reviewing insurance policies is a best practice within any estate plan review.
Further, it is easy to become so focused on estate tax planning that the appointment of fiduciaries and the manner and timing of intergenerational wealth distribution is often neglected. Of course, you likely want to transfer as much wealth (net of taxes) to your beneficiaries as possible. However, it is important to continually take a fresh look at appropriate selection of fiduciaries, as well as your wealth distribution plan (beneficiaries, amounts, timing, vehicle, etc.). Again, the new federal tax law does nothing to lessen the importance of these basic building blocks of a strong estate plan.
The Tax Cuts and Jobs Act of 2017 creates incredible opportunities for estate tax planning. In addition, the new tax law serves as a good reminder to review your estate plan to be sure that it is consistent with your current goals and that the plan is flexible to promote tax efficiency under today’s tax laws—as well as the unknown tax laws of the future.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. It is not designed or intended to provide financial, tax, legal, investment, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that, while this publication is not intended to provide tax advice, in the event that any information contained in this publication is construed to be tax advice, the information was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax related penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any matters addressed herein.Download Article