The Fiduciary Advisor

Estate Planning is Still Important Even with the Passage of the Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act of 2017 (the Act) signed into law by President Trump on December 22, 2017 made sweeping changes that affect individuals, businesses, trusts and estates.  This alert focuses on the impact of the Act on estate planning.

Under the Act, for the estates of individuals dying, or for gifts made, between January 1, 2018 and January 1, 2026, the estate and gift tax exclusion (commonly referred to as an “exemption”) doubles from $5 million to $10 million, as indexed for inflation.  In 2018, the exclusion amount is approximately $11.2 million for individuals and $22.4 million per married couple.  Although the Act does not explicitly mention the generation-skipping transfer tax; as the tax is based on the basic exclusion amount, the GST exemption should also be covered by the increased exclusion.

The Act did not change the tax rate for estates or gifts in excess of the exclusion amount.  The tax rate on the amount by which the estate or gift exceeds the federal exclusion amount, remains at 40%.  The Act also did not affect the portability election, which allows a deceased spouse’s unused federal estate and gift tax exclusion to be used by the surviving spouse (if properly preserved by filing a federal estate tax return for the first spouse’s estate).  However, the portability election does not apply to any unused generation-skipping transfer exclusion from the deceased spouse to a surviving spouse.

This increase in the exclusion amount will substantially decrease the number of estates that will be required to file an estate tax return.  With so few estates affected by tax, many may feel estate planning is even less important.  Yet, despite the increase in the federal exclusion, it is estimated that approximately $41 trillion of wealth will be transferred over the next fifty years.  This massive wealth transfer will not just occur among the ultra-wealthy, but includes billions of dollars that will likely transfer between everyday working W-2 wage earners or small business owners.  Yet, nearly 50% of individuals with children do not have a Will and over 40% of individuals over the age of 55 do not have one.  Yet, it is highly likely that individuals in a second (or more) marriage, who care for a loved one with a disability, who own a small business, or who have minor children still need estate planning.

It’s also important to keep in mind that certain tax changes in the Act are not permanent.  Portions of the Act have a sunset provision.  For example, in 2026, the exclusion amount for the estate tax reverts to previous levels ($5 million as adjusted for inflation after 12/31/2011), and loses half its value.  As such, many of the tax minimization strategies are still relevant.  Just what estate planning considerations should we be exploring?

Wills With Formula Clauses Should be Reviewed

A common estate distribution scheme is one that directs the estate to be divided into two shares at death:  Usually one share equals the decedent’s remaining federal estate exclusion amount or an amount equal to a state exclusion amount, and the other share is the rest of the estate.  One share is held in a trust for the benefit of the surviving spouse and potentially the children (often identified as a “Residuary or Family Trust”).  The other is either distributed outright to the surviving spouse or held in trust for the sole benefit of the surviving spouse (often identified as a “Marital Trust”).  Because of the new higher federal estate exclusion amount, the amounts allocated to the two shares by the formula may not be desired or anticipated:  too much may be distributed outright or held in trust.  In fact, the existence of a trust may no longer be needed from a tax standpoint.  Thus it may be wise to revise the Will to either simplify it (one may wish to give everything outright to the surviving spouse), or include language that allows for flexibility and deferred decision making (e.g. providing that not more than $x pass into a trust, and the remainder to the surviving spouse).

Lifetime Gifts

Lifetime gifts are still wise estate planning devices.  Shifting high-basis assets to the next generation may still be beneficial from an income tax perspective (e.g. children’s income is lower than parents).  Always remember though that a gift comes with the donor’s income tax cost basis.  So, a gift of low income tax cost basis stock to a child is not as beneficial to the child as cash or high tax cost basis stock or assets.

The future remains unclear.  As noted above, the Act contains a sunset provision for the estate tax exclusion and, in eight years, the law reverts to the prior exclusion amount (indexed for inflation).  There may be utility in gifting some or all of the increased exclusion amount out of a wealthy individual’s estate to their beneficiaries, thereby removing the appreciation of the gifted assets from the estate.  Further, if the exclusion amount does revert to a lower amount, it is unlikely (but still uncertain) that the government will constitutionally be able to “claw back” the excess gift.   Accordingly, gifting should not necessarily be limited to the federal annual exclusion amount ($15,000 per individual for 2018).

In some unique situations, there may be a benefit to gifting outright or in trust to an older generation.  For example, if an individual’s parents’ estates are valued well below the federal exclusion amount and such individual has very low basis assets, with proper planning a gift of such assets to the parents may decrease future tax liabilities.  The objectives would be to both benefit the senior generation while having the income tax cost basis stepped up at their deaths.  If the parent’s estate plan distributes the asset, either back to the child or to grandchildren, the asset is “returned” to the child (or grandchild) with the higher tax cost basis.  When the asset is later sold, there would be less tax liability, even with the lower capital gains tax rate.

Existing Irrevocable Trusts

There may be some beneficial planning opportunities related to existing irrevocable trusts; however, as each trust is unique, it is beyond the scope of this alert to provide all of the potential planning opportunities.  It is, therefore, recommended to review all existing irrevocable trusts.

529 Plans

Prior to the Act, contributions to a 529 Plan were typically removed from the donor’s estate and the income earned within a 529 plan was exempt from taxes as long as the distribution from the plan was made for qualified higher education expenses.  Under the Act, income tax-free distributions from a 529 plan now includes expenditures not to exceed $10,000 annually that may be used for elementary and secondary school tuition, as well as higher education expenses.

Charitable Planning

The Act increased the adjusted gross income limitation for donations to public charities from 50% to 60% for cash donations.

Income Taxes

Under the Act, income tax planning is even more critical.  The Act decreases the tax rate for six of the seven income brackets for individuals, and increases the standard deduction.  However, the Act also suspends several beneficial tax deductions at least through 2025.

The Act did not alter the income tax rates for trust and estates.  For 2018, the maximum tax rate is triggered for income in excess of approximately $12,700 (indexed for inflation) earned by an estate or trust.

In addition, the Act changed the Child’s Investment and Other Unearned Income Tax (the “Kiddie” Tax).  The Kiddie Tax is applicable to children age 18 or younger, as well as to full-time students age 19 to 23 (with some exceptions).  Under the Act, a child’s unearned income is taxed according to the tax brackets used for trusts and estates.  As such, a child is taxed at the highest rate for income in excess of approximately $12,700; whereas, the child’s married parents (filing jointly) will not be taxed at the highest rate until their income is in excess of $600,000.  Due to all of these changes (and others) special attention should be given to income tax planning in relation to trust distributions.

In conclusion, we recommend reviewing all of your estate planning documents whenever family and financial circumstances change significantly, after major events occur (e.g. marriage, divorce, birth of a child or a death in the family) and at least every five (5) years to make sure your plan still properly meets your needs.  However, with the passage of the Act, we recommend a review of your current estate plan, inclusive of any trusts, to ensure the plan continues to meet your objectives and there are no unwelcome surprises.  While there are some post-mortem actions that can address surprises, it is easier and wiser to have an up-to-date estate plan.

The Obermayer Trust and Estates Team: