The Tax Cuts and Jobs Act (the “Act”), signed into law at the end of December, includes major changes to the Internal Revenue Code. The Act is the most sweeping tax legislation to be enacted in decades and affects nearly all American taxpayers. Under the Act, the federal estate, generation-skipping transfer (GST) and gift tax exemption amounts have increased dramatically.
The estate tax exemption amount is the amount that an individual can pass at death to anyone without incurring estate tax, and the GST tax exemption amount is the amount that an individual can pass to grandchildren and more remote descendants without incurring GST tax. In addition to the estate tax exemption, there is the unlimited marital deduction, which permits an individual to transfer an unlimited amount at death to his or her spouse without any estate tax.
The federal estate tax exemption amount and the GST tax exemption amount were both $5.49 million per person for 2017 and, under the new tax law, increased to $11.18 million per person for 2018. These exemption amounts are scheduled to increase with inflation each year through 2025. On January 1, 2026, the exemption amounts are scheduled to revert to 2017 levels, as adjusted for inflation. The estate and GST tax rates (imposed on amounts in excess of the exemptions) are each 40%. The federal estate tax exemption remains “portable” between spouses; that is, to the extent the first spouse to die does not use all of his or her estate tax exemption, the unused exemption can be transferred to the surviving spouse. The GST tax exemption is not portable between spouses.
The federal gift tax applies to transfers during lifetime. The gift tax exemption amount is the same as the federal estate tax exemption amount (i.e., it was $5.49 million for 2017, increased to $11.18 million in 2018, and in 2026 is scheduled to revert to its 2017 level). After the lifetime gift tax exemption has been consumed, additional taxable gifts will trigger a federal gift tax at a rate of 40%. To the extent any gift tax exemption is used during life, it will reduce the available estate tax exemption at death.
There is an annual exclusion from the federal gift tax for gifts up to an amount of $15,000 per beneficiary in 2018 (to be adjusted for inflation in future years). This is the maximum amount that an individual can give to a recipient in a calendar year without using a portion of the lifetime gift tax exemption or paying gift tax. Lifetime gifts made in excess of this amount are taxable gifts; the donor (not the recipient) must file a gift tax return and pay any tax due.
Given the current political environment, there could be significant revisions to the estate, GST and gift tax laws even before 2026; either way, there is no assurance that the increased exemptions will remain permanent. In light of the Act, in certain situations it may be beneficial to modify existing estate plans or to make lifetime gifts to new or existing trusts for the benefit of children, grandchildren or other beneficiaries. Making lifetime gifts will take advantage of the temporary increased exemption opportunity and it also ensures that future appreciation on gifted assets takes place outside of the donor’s taxable estate. There is no state-level gift tax in DC, Maryland, or Virginia. Consequently, an additional benefit of using the federal exemption amount for lifetime gifts is minimizing (or eliminating) state estate tax in DC or Maryland (there is no state estate tax in Virginia).
For these reasons, we recommend reviewing your existing estate plan, especially if your plan divides assets between separate sets of beneficiaries based on the estate tax or GST tax exemption amount, and that you consider gift-planning opportunities.
Review of Existing Estate Plan
Testamentary Documents. We recommend reviewing wills and revocable living trusts that incorporate estate or GST tax planning to ensure that the estate plan will operate as intended in light of the substantial increase in the exemption amounts. Although many estate plans incorporate sufficient flexibility to adapt to changes in the tax law and will not require any modification, this will not be the case for all estate plans. For example, if an individual’s will provides that his children receive an amount equal to the federal estate tax exemption and for the balance to pass to his spouse (or to charity), the more than doubling of the federal estate tax exemption amount makes a significant difference in the allocation of his assets at death. It is important to ensure that the substantial increase in the exemption amounts will not unintentionally alter the allocation of assets among beneficiaries and disrupt the overall estate plan.
For married couples whose estate plan incorporates GST planning, it will be necessary to confirm that each spouse has sufficient assets titled in his or her individual name that will pass in accordance with his or her will (or revocable living trust) to carry out the estate plan and take maximum advantage of the increased GST exemption amount because the GST exemption is not portable between spouses.
Let’s look at an example: Harry and Wanda are married. Each of Harry and Wanda’s wills provide that an amount equal to the available GST tax exemption is to be set aside in a separate GST exempt trust to be administered for the lifetime benefit of the surviving spouse with the remainder passing in further trust for the benefit of children and grandchildren. Suppose Harry dies in 2018 and has assets valued at $5 million titled in his individual name that pass under the terms of his will, and Harry and Wanda have assets valued at $15 million titled in their joint names with rights of survivorship that pass to Wanda as the surviving joint owner outside the terms of Harry’s will. Under Harry’s will, the GST exempt trust will be funded with $5 million. The remaining $6.18 million of GST exemption available to Harry’s estate will not be utilized.
What could Harry and Wanda do differently? Harry and Wanda could divide their jointly held assets into their individual names. Harry would have sufficient assets in his individual name to pass under the terms of his will to maximize the use of the increased GST exemption amount of $11.18 million in 2018.
Existing Irrevocable Trusts. The increased GST tax exemption affords an opportunity to: (1) make a late allocation of GST exemption to a (currently) non-exempt trust; (2) make distributions from a non-exempt trust to skip persons (i.e., grandchildren or more remote descendants); or (3) modify a (currently) non-exempt trust so that it becomes an appropriate vehicle for GST planning and then allocate GST exemption to it.
Trustees and donors should review assets currently held in an irrevocable trust to consider basis adjustment planning opportunities to minimize capital gains tax exposure. Assets held in an irrevocable trust will typically not be included in the estate of the donor and, depending upon the terms of the trust, may not be includible in the estate of the trust beneficiary; as a result, such assets will not be eligible for a step-up in income tax basis at the death of the donor or beneficiary. In certain situations, it may be possible to return highly appreciated assets back to a donor or to distribute such assets to an elder beneficiary in order to achieve a step-up in basis if income tax considerations outweigh estate tax considerations in light of current tax rates, exemptions, asset values and cost bases.
Gift Planning Opportunities
Spousal Lifetime Access Trust. A spousal lifetime access trust (a SLAT) is a way for a married couple to optimize available gift and GST tax exemption amounts without entirely giving up access to the gifted assets. Each spouse can establish a SLAT for the benefit of the other spouse and their mutual children and grandchildren. Ideally, the spouse-beneficiary would not take distributions from the trust unless it were necessary (because the primary goal would be to preserve the trust assets for younger generations), but the trust assets are available to the spouse-beneficiary if needed.
Gift to a New or Existing GST Exempt Trust. A gift can be made to a new or existing GST exempt trust for the benefit of children and grandchildren to optimize the use of available gift and GST tax exemption amounts. With GST planning, the trust will not be included in the beneficiaries’ estates for estate tax purposes, so the trust assets will pass free of all estate tax to or in trust for grandchildren and more remote descendants.
Forgiveness of Outstanding Loans to a Child. A parent may wish to forgive an outstanding loan to a child to consume a portion of his or her available gift tax exemption; however, there may be more advantageous approaches to using the gift tax exemption.
Upstream Gifting. One planning technique to consider to achieve a full step-up in basis for income tax purposes for highly appreciated assets is “upstream gifting.” A gift of highly appreciated assets can be made to a trust that is purposely designed to cause inclusion of the trust assets in the estate of a modest-wealth parent of the donor (i.e., a parent whose estate will not be subject to federal or state estate tax). Inclusion in the parent’s estate means that the assets will obtain a full step-up in basis for income tax purposes; in addition, the parent could allocate his or her GST exemption to the assets. The trust structure ensures that the donor will control the ultimate disposition of the assets of the trust.
Other Gift and GST Planning Techniques. There are ways to leverage the gift and GST tax exemptions, including qualified personal residence trusts and sales to grantor trusts. Other estate planning techniques, such as intra-family loans, grantor retained annuity trusts (GRATs) and split interest charitable trusts, continue to be effective wealth transfer tools as well. It is important to note that some of these techniques work better in a low interest rate environment, so it may be advantageous to act before interest rates increase.
You may wish to consider how the new law affects your estate planning and to learn more about these and other gift-planning opportunities in light of the Act. If you have postponed a review of your estate plan pending the outcome of the tax legislation, this may be a good time to review your plan.
If you have questions about the impact of the new law on your estate planning, please feel free to contact any member of our Estate Planning and Administration Group.
State estate and inheritance tax planning remains extremely important. If you live in or own real property in one of the seventeen jurisdictions, including Maryland and DC, that impose a separate state-level estate or inheritance tax, you should remain attuned to changes in state tax laws. See the accompanying article.