|Helena S. Mock, Esq.|
As most of you know, the Tax Cuts and Jobs Act (TCJA) signed into law at the end of 2017 made extensive changes to the tax laws that will affect almost all Americans beginning in 2018. One of those changes will result in many fewer estates being subject to the 40% estate tax, and larger estates owing less tax.
Before the TCJA, the first $5 million (as adjusted for inflation in years after 2011) of transferred property was exempt from estate and gift tax. For estates of decedents dying and gifts made in 2018, this “basic exclusion amount” as adjusted for inflation would have been $5.6 million, or $11.2 million for a married couple with proper planning and estate administration allowing the unused portion of a deceased spouse's exclusion to be added to that of the surviving spouse (known as “portability”).
The new law, however, temporarily doubles the amount that can be excluded from these transfer taxes. For decedents dying and gifts made from 2018 through 2025, the TCJA doubles the base estate and gift tax exemption amount from $5 million to $10 million. Indexing for post-2011 inflation, brings this amount to approximately $11.2 million for 2018 ($22.4 million per married couple).
As a result of the large estate tax exemption amount, many estates no longer need to be concerned with the federal estate tax. Much of the planning done prior to 2011, and even many done since then, centered on estate tax avoidance but completely ignored minimizing income tax. But with so few estates now being subject to estate tax, planning for such estates can be devoted almost exclusively to saving income taxes. While saving both income and transfer taxes has always been a goal of estate planning, it was more difficult to succeed at both when the estate and gift tax exemption level was much lower. Below are some tax planning strategies you may want to revisit in light of the larger exemption amount and other recent changes in the law.
Gifts that use the annual gift tax exclusion are one example. One of the benefits of using the gift tax annual exclusion to make transfers during life is to save estate tax. This is because both the transferred assets and any post-transfer appreciation generated on the gifted assets are removed from the donor's estate. However, because the estate tax exemption amount is so large, estate tax savings may no longer be necessary. Making an annual exclusion transfer of appreciated property carries a potential income tax cost because the person receiving the gift receives the donor's basis upon transfer. Thus, the recipient could face an income tax liability (a capital gains tax) if the gifted property were later sold. If there is no concern the donor’s estate will be subject to estate tax, then the donor must consider whether it is wise to make the gift now or wait and leave the property to the individual at death because appreciated property which passes to a beneficiary at death will get a step-up in basis that will wipe out the capital gains tax on any appreciation occurring between the date the property was acquired and the date of death.
No longer is it necessary to engage in complicated planning to equalize the estates of both spouses so that each can take advantage of the estate tax exemption amount. Generally, a two-trust plan (generally referred to as a credit shelter (bypass, family, residuary, etc.) trust and marital trust) was established to minimize estate tax. “Portability,” or the ability to apply the decedent's unused exclusion amount to the surviving spouse's transfers during life and at death, became effective for estates of decedents dying after 2010, but the concept wasn’t made permanent until 2013. As long as the election is made, portability allows the surviving spouse to apply the unused portion of a decedent's applicable exclusion amount (the deceased spousal unused exclusion (DSUE) amount) as calculated in the year of the decedent's death. The portability election gives married couples more flexibility in deciding how to use their exclusion amounts.
Estate exclusion or valuation discounts that do not preserve the step-up in basis may no longer be desirable given the excessive exemption amount. Some strategies previously used to avoid inclusion of property in the estate may no longer be worth pursuing. Instead, it may be better to have the property included in the estate or have the property not qualify for valuation discounts so that the property receives a step-up in basis, or a larger (new) basis at death. The gap between the transfer tax rate and the capital gains tax rate has narrowed, making strategies that do not preserve the step-up in basis less desirable.
For all of these reasons, and many more which are not discussed here, if your estate plan has not been updated since 2013, it merits review. The increased exclusion amount may have an impact on your plan. Whether you should make any changes depends on your individual goals and circumstances.