12/18/2018 by Patrick W. Herman
Great news: the new “Tax Cut and Jobs Act” (“TCJA”), doubles the estate tax exemption amount from $5.49 million per individual (the 2017 exemption amount) to $11,180,000 million. (For convenience, this article will use the $5.6 million projected exemption amount for 2018 before TCJA and $11.2 million). The new higher number will be adjusted for inflation. This means at least until 2026 married couples may have up to $22.4 million in assets and avoid the estate tax. Since very few individuals have assets in excess of the new exemption amount, this tax law change will even further reduce the number of people exposed to the tax who are required to file an estate tax return. (It is estimated that less than 2,000 estates will be required to pay tax compared to over 5000 for 2017).
This means that most of us can concentrate our estate plans on the “real issues, the ones affecting our families and the proper and orderly disposition of our assets. We may no longer need the complexity of “ILITs” (irrevocable life insurance trusts) or “IDGTs” (intentionally defective grantor trusts). We will likely still need to consider the use of trusts to meet our lifetime and testamentary goals, such as avoiding probate or distributing our assets over time, to avoid waste or the unwise use of our savings by young or immature beneficiaries. Trusts provide for the orderly distribution of assets over time, in a protected fashion. Do you want significant assets (e.g. $100,000) being distributed to a young 18-year-old? Would the result be the prudent use of the funds for education? Or, perhaps a new car and “a year off” enjoying the pleasant company of many new friends?
Who is adversely affected by the increase in the exemption? One example is charities. Do you still need a testamentary charitable gift or charitable remainder trust? You do if you have a charitable intent and desire to benefit your favorite charity, church or alma mater. However, it is likely some individuals will abandon their charitable goals with the new higher estate tax exemption, since they will no longer need to give away assets to avoid the estate tax.
IMPORTANT NOTE: The new estate tax exemption amount is only effective until December 31, 2025. Afterwards, unless there are more changes, the provisions will revert to the 2017 rules and the $5.49 million exemption amount. However, at least we should be able to benefit from the continued indexing of the credit amount. The hope is that the estate tax will be eliminated in its entirety before the 2025 sunset. However, as they say, “hope is not a plan.” What do YOU do in the interim? Assuming you own assets in excess of $5.6 million, can you prudently count on the ultimate repeal of the tax when hundreds of thousands of dollars may be at stake? The estate tax has been in place since 1916. Remember 2010, when the estate tax was eliminated, only to be brought back the same year? Our thought is to plan your estates based on current law, rather than predict what the law may be when you die.
Estate tax planning during 2018-25 falls into four zones, depending on the level of your assets:
- LESS THAN $5.6 MILLION IN ASSETS:
At this level you can focus on your lifetime and testamentary goals in carefully designing and reviewing your estate plan, however, you must be mindful of the appreciation of your wealth over time, especially if your assets exceed $4 million. As we know, we are living longer and a plan for a “safe” $4 million estate may not last 10 -15 years with the appreciation in your portfolio to $6 million or higher. Remember what the stock market did in 2017?
- BETWEEN $5.6-$11.2 MILLION IN ASSETS:
There are significant opportunities available in this zone to minimize risks of inadvertent taxation. If the projected value of your assets in 2026 will be over the $5.6 million limit you may wish to take available actions to reduce your exposure, since under current law the new higher exemption amount will revert to the prior indexed limit. To reduce your exposure, see the ideas under zone 3, below. Also consider:
- Significant gifts to family members of amounts in excess of $5.6 million, to “use” the new higher exemption amount before it goes away in 2025. Note: there is some risk of a “claw-back” of this amount when the exemption goes back to its pre-TCJA level, however at this time the consensus appears to be that will not occur. Also, even if there is a claw-back, the gift will shift the post-gift appreciation to the family members. Another limitation to consider on these gifts is the loss of a step-up in basis.
- Gifts of the extra exemption amount may be direct, or through trusts such as a “dynasty” trust for family members.
- Use of “I love you” wills and trusts containing “disclaimers” makes it possible for a surviving spouse to minimize estate taxes at the first spouse’s death. A spouse may be given the amount in excess of $5.6 million but have the opportunity to disclaim it to younger family members when the exemption level decreases.
- If you believe the $11.2 limit will survive past 2025, you may wish to consider the opportunity to “reverse” some of your previous estate planning transfers to minimize expected future income taxes with a step-up in basis (which was retained under TCJA). (Note, don’t wait until the last minute to do this, there are special rules that can limit this opportunity).
- Another basis step-up opportunity exists with gifts to parents who are below the exemption limits. (Again, don’t wait until the last minute).
- You may also wish to unwind certain arrangements, such as life insurance trusts, which may be no longer needed.
- SINGLE INDIVIDUAL GREATER THAN $11.2 MILLION IN ASSETS:
In this zone, we are thankful for the increase in the exemption, but we must also consider some of the options that were available before the increase, for example:
- Annual gifts of up to $15,000 (for 2018) per individual;
- Educational and medical gifts paid directly to institutions/providers;
- Charitable Trusts;
- Irrevocable Life Insurance Trusts;
- Grantor Retained Annuity Trusts;
- Qualified Personal Residence Trusts; and
- Intra-family sales, for example to a “defective” grantor trust, and other “freeze” techniques such as low interest loans.
The use of these and similar options will help eliminate or minimize estate taxes attributable to assets in excess of the $11.2 million limit.
- GREATER THAN $22.4 MILLION IN ASSETS:
For married couples, the combined exemption of $22.4 million will exempt most estates from estate taxes. For those above this level, the higher exemption will save significant taxes, however additional planning to minimize taxes above that level suggests consideration be given to the use of the options described above.
Overall, the new tax law provides significant opportunities and requires new considerations. A review and adjustment of your current estate plans and documents is in order. For example, if you have an older “tax will” with a formula tax adjustment clause (for example a “marital trust” and “family” or “credit shelter” trust) your spouse may be significantly underfunded by reason of the new exemption amount. The next step is to review your documents and consult with your advisors. After properly conforming your documents to your wishes, watch for new laws or IRS Regulations that may affect your decisions. Lastly, plan on repeating this process as we approach the “sunset” of this legislation in 2025. Your family will benefit from your diligence.