New Tax Law Enables Large Tax-Free Transfers and Necessitates Estate Plan Review

Personal & Succession Planning Update

Date: January 03, 2018

President Trump signed into law the Tax Cuts and Jobs Act, which became effective January 1, 2018. The new law includes individual and corporate tax changes that have been widely publicized, but it also includes significant favorable changes to the estate, gift and generation-skipping transfer (GST) tax laws, which have been less publicized. Under the new law:

  • In 2018, each individual is permitted a gift/estate tax exemption (i.e., the amount an individual can transfer during life and/or at death without paying gift or estate tax) of $11.18 million (reduced by the amount of exemption used in prior years), which is more than double the amount allowed in 2017. This means married couples can transfer up to $22.36 million free of gift or estate tax.
  • In 2018, each individual is also permitted a GST tax exemption (i.e., the amount an individual can transfer to persons who are more than one generation below him or her, such as grandchildren, without paying GST tax) of $11.18 million (reduced by the amount of GST exemption used in prior years).
  • A surviving spouse who is a U.S. citizen or U.S. resident for gift/estate tax purposes may continue to utilize the unused gift/estate exemption of a predeceased spouse who was a U.S. citizen or U.S. resident for gift/estate tax purposes (but not the unused GST tax exemption amount), provided a proper portability election is made on a timely filed federal estate tax return for the estate of the predeceased spouse.
  • The maximum rate for the estate, gift and GST taxes continues to be 40 percent.
  • The annual gift tax exclusion for 2018 increased to $15,000 per donee.
Increased Exemptions Expire After 2025

Unless Congress acts to extend the increased exemptions, on January 1, 2026, the exemption amounts are scheduled to revert back to pre-2018 levels ($5.49 million, indexed for inflation). Of course, Congress could always reduce or raise the exemption levels prior to 2026. There is some uncertainty as to whether gift tax that is avoided for gifts that take advantage of the increased exemptions may become due if exemptions revert back to pre-2018 levels, although the new law directs the IRS to clarify this issue in Regulations. Nevertheless, clients with substantial wealth will want to give serious consideration to additional lifetime gifting now in order to take advantage of this unique opportunity while it is still available.

Many Married Couples’ Estate Plans Affected

These changes provide incentive to review all estate plans, but married couples will want to pay special attention to their estate plan if it divides assets of the first to die based on a formula clause tied to the exemption amounts in effect at the date of death (commonly referred to as A-B trusts). Many factors go into the design of an estate plan for a married couple that are completely independent of tax considerations, but a number of plans that were drafted prior to 2018, when the exemption amounts were much lower, provided for the allocation of assets based on available exemptions at death. These plans may now produce unintended results; for example, all assets of a first-to-die spouse passing to other family members instead of the surviving spouse. For a married couple, tax considerations now fall into three categories:

  • A married couple with a combined net worth valued at less than the amount of one exemption (i.e., less than $11.18 million) may wish to design their estate plan without a formula clause at all. Transfer taxes are not an issue under the new law for these couples. We encourage a married couple in this category to focus on other planning considerations, such as flexibility, the management of property and income tax planning.
  • A married couple with a combined net worth valued between the amount of one and two exemptions (i.e., between $11.18 million and $22.36 million) will weigh use of the federal estate tax exemption amount based on whether they believe their assets will appreciate substantially before the surviving spouse’s death, the possible loss of an income tax advantage for those inheriting their assets at the surviving spouse’s death, and whether they want to use the GST tax exemption on the death of the first to die for assets to be transferred to trusts for children or grandchildren. We encourage a married couple in this situation to consider alternative plans, such as disclaimer planning or implementing spousal trusts that could qualify for the marital deduction or take advantage of the available exemptions based on elections made after the first to die. Such plans allow a married couple to simplify their estate plan and provide flexibility to defer decisions concerning estate tax and income tax planning until after the death of the first spouse, when the overall planning picture is more clear.
  • Finally, a married couple with a combined net worth valued at an amount higher than two exemptions (i.e., in excess of $22.36 million) will likely stay the course with a formula clause. But these couples too will want to review the overall design of their estate plans to determine if the value of assets allocated to trusts as a result of the increased exemptions is consistent with their goals. As previously discussed, couples in this category may also want to consider additional lifetime gifting due to the increased exemption amounts while available.
It Is Always Wise to Review

There are many non-tax reasons to review one’s estate plan, even if it is not impacted by the recent changes in tax law. Members of our Personal & Succession Planning group advise on estate planning under the new tax law to ensure that plans reflect current goals and objectives.

FOR MORE INFORMATION

For more information, please contact a member of our Personal & Succession Planning practice group.

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