THE TAX CUT AND JOBS ACT OF 2017: Highlights and Estate Planning Considerations
Just three weeks after the Tax Cut and Jobs Act of 2017 was introduced, the final bill was passed on December 20, 2017, and signed into law on December 22nd. This comprehensive tax overhaul dramatically changes the rules governing the taxation of individual taxpayers until 2026, providing new income tax rates and brackets, increasing the standard deduction, suspending personal deductions, increasing the child tax credit, limiting the state and local tax deduction, and temporarily reducing the medical expense threshold, among many other changes. This alert focuses on changes to the estate, gift and generation-skipping transfer (GST) tax aspects of the law and how those changes may impact our clients.
- President Donald Trump signed the Act into law on Dec. 22, 2017.
- Most of the Act’s provisions are effective as of January 1, 2018.
- The Act was passed in the U.S. Senate along party lines and did not garner the required 60-vote supermajority required by the Byrd provision; therefore, the duration of many of its provisions are limited to 10 years.
- Further, due to budget considerations, a number of the Act’s provisions with respect to transfer taxes – including, but not limited to, the increased estate, gift and GST exemptions – are effective only until December 31, 2025. If Congress takes no further action, these provisions will sunset and prior law will be reinstated as of January 1, 2026.
- Because the Act doubles the estate, gift and GST tax exemptions (albeit temporarily), it is important for clients to review their existing estate plans, reconsider current strategies and explore new planning opportunities.
In 2017, the federal estate, gift and GST tax exemption amounts were $5,490,000 per person with a tax rate of 40% on any amount above that. The new Act doubled the exemptions that were originally put in place in December 2010. The new Act provides that the federal estate, gift and GST tax exemptions will be $10,000,000 (indexed for inflation each year). After the inflation adjustment, these tax exemptions for 2018 are essentially $11,200,000 per individual. The 40% tax rate remains for amounts in excess of the federal exemption amounts.
The new Act also continues the portability provisions that were introduced in December 2010. These provisions make the federal estate and gift tax exemptions (not the GST tax exemption) “portable.” Portable means that a surviving spouse may utilize the unused federal estate and gift tax exemption of his or her deceased spouse. The portability provisions allow a married couple to pass assets equal to their combined exemptions without having to establish a “Credit” or Family Trust at the death of the first spouse. In order to preserve a deceased spouse’s exemption, a federal estate tax return (Form 706) must be filed for the estate of the first spouse to die. Including portability, a married couple in 2018 now has up to $22,400,000 of exemption from federal estate and gift tax.
Due to Congressional budget rules, the provisions that double the exemptions are scheduled to “sunset” in the 2026 tax year. What this means is that without future legislative action, these exemptions will revert back to the $5,000,000 amount (plus inflation adjustments) in 8 years. Moreover, if the balance of power shifts in Congress, Democrats may revisit the changes sooner than 2025, potentially resulting in these exemptions being substantially lowered within the next few years. Meanwhile, the U.S. Department of the Treasury has not yet addressed how the scheduled contraction of the exemption amount will be handled.
In light of the above changes to the estate, gift and GST tax laws, we recommend that you review your current estate planning documents to ensure that these changes do not adversely affect your estate plan.
Formula Funding Concerns
Many existing estate planning documents include what is known as a “formula funding clause,” which provides a formula for dividing up assets and the funding of various trusts. A formula funding clause can take many forms, but is sometimes utilized to fund certain types of trusts such as “credit trusts” or “GST trusts” with an amount of assets tied to the federal estate, gift and GST exemption amounts. Since those amounts are now doubled, any formula clause that is tied to the federal exemption amount could significantly distort the entire estate plan.
Clients should consider the purpose and nature of certain deductible bequests in light of the potential changes. Certain techniques – such as “charitable lead” or “charitable remainder” trusts – minimize estate tax by splitting the interests in a trust between charitable and non-charitable beneficiaries. Those techniques often were incorporated into estate plans based on a conscious decision by clients to shift assets that would otherwise have gone to the U.S. Treasury to one or more charities. Clients may want to revisit such plans and consider whether the size and nature of those bequests are still appropriate, especially in plans where the interests of their heirs might be unnecessarily delayed.
For clients who have already used their lifetime exemptions, the Act presents an incredible opportunity to further advance such wealth planning. Additional planning considerations include the following:
- Plan Now in Case Exemption is Reduced Prior to 2026. Since the Act does not repeal the estate tax, ultra-high-net-worth clients should continue to plan for a federal estate tax and even those clients with a more “moderate” net worth should consider expanding existing gift planning in the event that the transfer tax exemptions revert to pre-2018 amounts – or lower – in the future, and to continue reducing their Washington state estate tax exposure.
- Engage in New Transfer Tax Planning Strategies. Those clients with estates that will be subject to estate tax even at the increased exemption amount should consider taking advantage of the expanded exemption through the use of leveraged transactions to maximize wealth transfers. For example, using sales to irrevocable grantor trusts outside of the grantor’s estate, particularly where there is an opportunity to further leverage the increased exemption amount through the use of discounting (the IRS withdrew the proposed Internal Revenue Code Section 2704 Treasury Regulations so additional discounting of the transferred assets may also be possible).
- Revisit and Refine Existing Planning that Involves Notes. For existing planning transactions that utilize promissory notes (such as a sale transaction to a grantor trust), it’s worth considering whether it could be advantageous to use the additional exemption to lower or eliminate the promissory note through a gift. If there are cases where the balance of the note exceeds the additional exemption amount, it may be beneficial in some situations to make an additional gift to the trust to help in repaying the note.
- New Basis Planning Considerations. Any planning will need to continue to balance the use of the increased exemption applicable to gift transactions against the loss of a step-up in basis in transferred assets at death. Those clients with taxable estates will need to consider whether it is feasible to use the newly increased exemption amount to give away high-basis assets, while retaining low-basis assets in their estates. The Act’s sunset – and potential for early repeal – add to the difficulty of this calculation.
- Alternative Planning Techniques. There may be alternative uses of the increased exemption available, such as forgiving existing loans to family members (or Trusts) and terminating unworkable split-dollar life insurance agreements. For example, an private split-dollar arrangement that has become prohibitively expensive based upon the insured’s age may be terminated by using the donor’s increased exemption to give away the split-dollar receivable.
As mentioned above, the new Act also has an effect on the income tax rates for all taxpayers, curtails itemized deductions, lessens the impact of the Alternative Minimum Tax, and expands the benefits of 529 Plans. You should consult with your accountant or other tax advisor to discuss these changes. These income tax issues can have an impact on estates and trusts, and we would be happy to discuss these matters with you, especially if you are a trustee or beneficiary of an estate or trust.
If you would like to discuss how these changes might affect you and your current estate plan, or if you have any questions about the new tax law, please don’t hesitate to call or email us.
This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting an attorney.