On December 22, 2017, President Trump signed into law the largest federal tax overhaul in more than 30 years. This law, technically called “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” will have a major impact on estate planning. Beginning January 1, 2018, the unified exemption for gift, estate, and generation skipping transfer (“GST”) tax is approximately $11.2 million per tax payer. Married couples may transfer more than $22 million without paying a transfer tax. For those with taxable estates, this temporary doubling of the estate, gift, and GST tax exemptions opens opportunities to forever protect assets from transfer taxes. For others, it could provide opportunities for a basis adjustment at death that did not exist under prior law. Here are some things that you need to know:
The increased exemptions create opportunities to leverage gifting opportunities. For several reasons, making a lifetime gift using some or all of the gift tax exemption is more tax-efficient than waiting to use the same exemption at death. By moving assets to a trust, the grantor removes the asset from his or her estate. Neither the assets nor the growth in value over the grantor’s life will be included in the grantor’s estate or subject to estate tax. If the gift is to a “grantor” trust, the income remains taxable to the Grantor. This further leverages the gift because the taxes that the Grantor pays on the income is essentially a tax-free gift to the trust beneficiaries. This has always been an important tool for assets that are expected to appreciate. It is particularly effective now, because the estate tax exemption at death may be much lower than the current gift tax exemption. I will explain that in more detail below. Under prior law, the mechanics of the estate tax calculation could “claw back” some of the increased exemption and require the lower exemption in place at the time of death to apply. However, the new act directs the Treasury Department to issue regulations to eliminate claw-back. There are no absolutes. However, the potential for clients with large estates to avoid transfer taxes are greater than ever.
The increased exemptions create the ability to protect property for multiple generations. The GST tax imposes a tax on gifts and bequest above the applicable exclusion that avoid gift or estate tax by skipping one or more generations. It is the government’s defense to an end-run around the estate and gift tax. The primary target of the GST tax are certain trusts that provide distributions for the benefit of a child for life with the remainder continuing on for the grandchildren. Under the current estate tax rules, those assets would not be taxed at the child's death unless the child has sufficient powers over the trust to cause the assets to be included in the child's estate. In this case, the economic benefits of the trust do not "skip" the children, but the estate transfer tax is "skipped" at the death of the children. The GST tax would be imposed when the grandchildren receive the trust assets. By allocating the GST exemption to a trust, the assets held in the trust can pass from generation to generation without incurring gift or estate tax. For the time being, there is a historic opportunity to create dynasty trusts. The GST tax is not portable. So if one spouse passes away without using his or her GST exemption, it is forever lost.
These planning opportunities may be temporary. We don’t know how long this will last. The increased exemption amounts expire on December 31, 2025 if the law is not changed before. In the Senate, all Republicans voted for the bill and all Democrats voted against it. In the House, twelve Republicans voted against it. Modification of this bill is guaranteed to be an issue for 2018 mid-term elections and the next presidential election. This legislation could be heavily modified if the political pendulum swings in the other direction. Of course, it could also be renewed in 2026. The present value of future savings diminishes with time. It is also important to note that there has never been a reduction in exemption amounts once they have been raised. However, there has never been such a large change in the exemption amount. There is vehement opposition to this provision of the bill and a divisive political climate. This bill was touted as tax relief to the middle class. There is not much of an argument that this portion of the bill helps the middle class. Although no one knows the future, many of these opportunities may go away permanently by 2026.
There are several different ways to leverage these planning opportunities. This may include generation-skipping "dynasty" trusts, insurance trusts, intentionally defective grantor trusts, grantor retained annuity trusts, and outright gifts. However, many clients may wish to retain their wealth for their own use during their lifetimes, passing it to future generations only at death. Others may be charitably inclined. This could be a perfect opportunity for married couples to use a spousal lifetime access trust (“SLAT”). A SLAT allows one spouse to make a gift to an irrevocable trust that names the other spouse as a lifetime beneficiary of the trust. The gift constitutes a completed gift to remove the asset from the gifting spouse’s estate, and “freezes” the value of the gift for transfer tax purposes, but ensures that he or she will still have access to trust assets through the donee spouse as long as they remain married to each other. A SLAT will offer increased protection against future changes to the tax laws with little downside risk. This may also be an appropriate time to leverage gifts to support the funding of life insurance trusts. With the capital gains rate and the net investment income tax remaining the same as under prior law, charitable remainder trusts will remain good options for clients who wish to sell appreciated assets.
There are important capital gains issues that must be considered. Any assets transferred out of the grantor’s estate will not receive a step up in basis upon the Grantor’s death. Clients with low basis assets that will likely be sold by their heirs may wish to ensure that these assets remain in their estate. If the asset under consideration is not likely to be sold even after death, or in the case of assets with a high basis, such as cash or recently acquired property, then the estate and GST tax benefits may outweigh the benefits of the basis adjustment for taxable estates. For some clients, it may be appropriate to reverse prior gifting to move them back into your estate. Every situation is different.
Flexibility is more important than ever. We build in as many tools as possible to add flexibility to estate plans by using tools like trust protectors, “second look” estate tax planning, and strategic uses of powers of appointment. These provisions are more important than ever. But those strategies only work to preserve options that are available at the time you need them. If this law changes before 2026, or it is not renewed, some of the opportunities available now may never exist again.
There may be an unanticipated impact on existing estate plans. The increased exemptions may skew some existing estate plans. This is particularly true if for plans that were drafted before 2012. Many estate plans for married couples use a formula to divide assets at the first death between a “marital” portion passing to or held in a trust for the surviving and a “bypass” portion intended to bypass the estate of the surviving spouse. The bypass portion is typically allocated to a trust for the surviving spouse and/or descendants. Similarly, at the second death, the estate plan may have a formula dividing assets, based on the GST exemption, between children and grandchildren. Depending on the exact language of the document, this division may need to be different now because of the much larger exemptions. We have seen numerous estate plans that are drafted in a way that would require all assets under the exemption amount to be placed in the bypass trust. This can have significant capital gains tax implications. It is important for clients to review their estate planning documents to make sure they continue to reflect their intentions.
Everyone needs to review their existing documents to determine the impact of tax reform. For the very wealthy, there may be new opportunities to save millions in transfer taxes. For others, there may be opportunities to avoid or minimize capital gains.
We would be happy to discuss the effects of tax reform on your particular situation.