By Kenneth S. Kleinkopf
The new tax law—formally known as the Tax Cuts and Jobs Act (the “Act”)—is effective as of January 1, 2018. This article addresses some of the changes to the federal estate, gift, and generation-skipping transfer tax laws, as well as issues to look for in updating your estate plan.
The Act doubled the federal estate, gift, and generation-skipping transfer tax exemptions through the end of 2025. Effective January 1, 2018, each individual has a federal exemption of approximately $11.2 million, and married couples can combine their exemptions for a total of approximately $22.4 million. These lifetime exemptions will be adjusted annually for inflation, beginning in 2019. But, as of January 1, 2026, the estate tax laws are scheduled to revert to the pre-Act law, which provided an exemption of $5.49 million per individual in 2017 (but will continue to be subject to inflation adjustments). The value of a person’s estate that exceeds his or her remaining applicable exemption will be subject to a flat tax rate of 40%.
In addition to the higher lifetime exemptions, the annual exclusion amount—which is the amount that can be given to any individual without the requirement of reporting the gift on a gift tax return (Form 709)—has increased from $14,000 to $15,000 per year. This annual exclusion limit is per individual and married couples can collectively gift up to $30,000 per year to any individual. For example, if husband and wife have three children, they can gift a total of $30,000 to each of their children (e.g. a total of $90,000) annually without being required to file a gift tax return. However, there remains an unlimited exclusion regarding gifts for tuition and medical expenses that are paid directly to the respective institution. For example, grandma and grandpa can pay their grandchild’s tuition, if paid directly to the educational institution, and still give $30,000 to their grandchild without the requirement of filing a gift tax return.
The doubling of the federal estate, gift, and generation-skipping transfer tax exemptions has important consequences for many people. More individuals and married couples will now have estates that are no longer subject to federal estate tax liability (at least through 2025). Individuals who already used all of their federal gift tax exemption under the 2017 limits may want to consider making additional gifts to take advantage of the increased exemption. In addition to outright gifts, this could include more sophisticated gifting strategies, such as charitable remainder trusts (particularly with the increase in the charitable deduction as discussed below), grantor retained annuity trusts or intentionally defective grantor trusts (e.g. sale of certain assets to an irrevocable trust). While it is possible that the increased exemptions will be extended beyond 2025, it is far from certain.
You should reconsider the terms of your current estate plan to ensure the provisions in your documents reflect your wishes and planning strategy. Revocable trusts often use formulas to calculate the amount to fund certain trusts upon the first spouse’s death. You should revisit your plan to review whether any formulas in your documents will have unintended consequences given the new estate tax exemptions. Certain plans could result in more assets passing to a subtrust (which typically occurs upon the death of the first spouse) than originally anticipated. Other plans could be simplified by the increased exemptions, such as with the use of a disclaimer trust.
Regardless of whether an estate is subject to estate tax liability at death, assets will continue to receive a step-up in basis for federal income tax purposes upon a decedent’s death (which will not expire at the end of 2025). For married couples owning community property, both spouses’ halves of the community property also will continue to receive a full step-up in basis upon the death of the first spouse.
The Act also makes many changes to personal income tax rates, corporate tax rates, taxation of pass-through businesses, deductions for charitable gifts (increases the deduction from 50% to 60% of adjusted gross income for gifts to public charities), use of 529 plans, like-kind exchanges, and other tax matters. For example, the new federal deduction for business income from pass-through entities may be relevant to certain business owners, regardless of whether the business is a sole proprietorship, s-corporation, partnership or limited liability company. However, like the estate tax, the pass-through deduction is set to expire at the end of 2025.
If you are interested in reviewing your estate plan, or have questions in general regarding these changes, please contact us to schedule a consultation.