Estate Planning for the Middle Class After Tax Reform

If you prepared an estate plan 20 years ago, there is a good chance that you considered estate taxes, even if you had an estate of moderate size. But after the American Taxpayer Relief Act of 2012 and the repeal of North Carolina’s inheritance tax in 2013, a married couple in North Carolina could give away more than $10 million either during life or at death without paying any transfer taxes. This made estate taxes irrelevant to most people. Those who did face the possibility of paying estate taxes could usually avoid them with minimal planning. 

The tax reform bill passed last December doubles the estate, gift, and generation skipping transfer tax exemptions. This means that even fewer people will pay estate taxes than before. It also clears the way to focus on other issues, such as income and capital gains tax planning, asset protection and disability planning.   

One of the most important changes in planning for the middle class is that taxes do not always have to drive your estate plan. If you have a large life insurance policy, cash, non-qualified investments, or a business, you can focus on how to protect yourself and your beneficiaries instead of minimizing taxes. With taxes out of the way, we can plan for what happens when one spouse lives much longer than the other, the surviving spouse remarries in his or her 70s, or you have an extended stay in a nursing home. We can also think about how to protect your children and grandchildren without being boxed in by estate tax implications.

Income and capital gains are the taxes that can cause problems for the middle class. Most of our clients' largest assets are real estate and retirement accounts. These two types of property highlight the different tax issues that are faced by most people.

For those who have large retirement accounts, it is important to balance asset protection with tax efficiency. There are numerous problems that can occur with retirement accounts. Efficient tax planning has little benefit if your son’s inheritance caused him to lose Medicaid and SSI. Your investment returns are irrelevant if your IRA ends up being lost to a judgment creditor or going to the son-in-law you have never liked. And you probably didn't max out your 401K contributions for 40 years so your 18-year-old grandson can cash in a $100K IRA to buy a $70K pickup truck. All of these problems are fairly easy to prevent if you don’t mind if your children have to pay income taxes on the entire account balance within five years of your death. That might be fine with a $50K IRA.  But the stakes go up if your IRA is worth $1 million. Then we have to do more complicated planning to accomplish your goals.

For estates that are comprised largely of appreciated property, capital gains taxes are a bigger issue. We regularly see this with family farms and beach houses. Older estate plans may be the exact opposite of what you need in the current tax environment. For decades, estate planners have advised clients to establish trusts for surviving spouses that intentionally do not qualify for the marital deduction and do not cause estate inclusion when the surviving spouse later dies. These trusts use a decedent’s estate tax exemption to make sure the exemption isn’t wasted. They were very effective 20 years ago. But if you have a tax-driven estate plan that was drafted before 2012, it could ensure that your family pays more taxes rather than fewer. Old fashioned second marriage protection often consisted of leaving property to your spouse for life and then to your children. We have seen this cause massive capital gains problems. All of these capital gains issues can be prevented.  

For most people, the new tax bill clears the way to ignore transfer taxes and focus on other issues. Every tax law change is eventually replaced by another. The estate tax provisions of the new tax bill go away after 2025 if they are not changed before. Therefore, flexibility is more important than ever. Everyone should take the time now to review your estate plan to make sure it accomplishes your goals under current law.