Estate Planning in the Aftermath of the 2017 Tax Cuts and Jobs Act
June 13, 2019 Written by Russ Bucklew, Partner, CFP®, JD; Mary Ann Hennelly-Favata, CFP®, Senior Client Advisor; and Ena Dashi, Senior Client Associate
Now that it has been almost 16 months since the passage of the 2017 Tax Cuts and Jobs Act (TCJA), it’s time to come up for air and ask the question: what is the overall impact on estate planners and their clients?
For estate and gift tax planning, the 2017 TCJA made a significant amendment to the laws. The fundamental change was an increase in the exclusion amount. The amount that an individual may gift to other individuals, during their life or exclude from his or her estate at death (if unused), rose from $5.49 million per person to $11.4 million. Therefore, married couples may now exclude $22.8 million from their estate without any estate tax consequences. Since the generation-skipping transfer (GST) tax exemption is based on the gift and estate tax exemption, the new GST exemption amount has also been increased to $11.4 million.
Now that we have a high exemption, the false assumption is that fewer people will need sophisticated death tax planning. Many estate planning checklists will need to be revised now that fewer people will be subject to the estate tax. According to the Tax Policy Center, less than 0.1% of the 2.7 million people who died in 2018 will pay an estate tax. However, given the potential change in political parties in the executive and congressional branches and the 2017 law sunsetting without congressional action in 2025, the need for planning is more critical than ever.
Question: Why should I worry about my estate plan if I am not impacted or taxed by the law changes and higher exemptions?
Answer: There are many reasons to plan. Here are three considerations:
First, nearly all of the legislation that affects individual taxes, including the estate and gift taxes, is set to expire at the end of 2025. This means that the exemption amounts could decrease to 2017 levels (adjusted for inflation) within six years.
Second, a new Congress could change the law before then and bring the exemptions back down to 2017 levels or, worse, even lower. For example, Senate Bill S. 309, introduced by Bernie Sanders, is affectionately called the “99.8 Percent ACT” for its anti-wealthy sentiment, and it indicates a significant effort in this direction. A key provision includes lowering the estate tax exemption from $11.4 million to $3.5 million, reducing it to the 2009 level, shaving off almost $8 million of the exclusion that could be lost forever. Sanders’ proposed legislation will also reduce the gift tax exemption to $1 million. So, even though some intend to postpone until 2024 or 2025 to make gift tax free transfers under the lifetime exemption, waiting may be costly. Therefore, a family may not need to worry about the estate, gift, or GST tax today, given the sunset provision and the changing political winds; it is future generations—children and grandchildren—who almost assuredly will be impacted. Accelerating the restoration of the pre-TCJA exemption levels would reduce the deficit while affecting just a few thousand large estates. Taking such action now could also curb enthusiasm for making the higher thresholds permanent when they expire at the end of 2025. Our estate planning checklists should prepare for any scenario.
Finally, estate planning is never exclusively about tax minimization. For most individuals, wealth is lost in nontax ways, such as elder financial abuse, divorce, lawsuits, and spendthrift heirs. Modern estate planning prioritizes asset protection (protecting trust assets from potential creditors or spendthrift beneficiaries) alongside tax efficiency and other considerations. Other considerations include minor children, pets, friends, and business partners. Plan for the end of life decisions and incapacity. Address how to provide for a potential beneficiary that is disabled or with special needs.
The higher exclusion amounts are shifting the emphasis from transfer tax to income tax planning for many estate planners’ checklists and their clients.
One key area is the emphasis on taking advantage of the basis step-up. When an asset is passed on to a beneficiary, its value is typically more than what it was when the original owner acquired it. A step-up in basis is the readjustment of the value of an appreciated asset for tax purposes upon inheritance, determined to be the market value of the asset at the time of inheritance. Many estate planners’ checklists should incorporate analysis and opportunities to avoid income tax through planning on low basis assets.
One area of renewed interest is the formula General Power of Appointment Clause (GPOA). The power of appointment is given to an older (or ill) beneficiary with a net worth less than his or her remaining exemption amount. The strategy builds in flexibility with a formula that does the following: 1) only applies to assets with a basis less than fair market value (FMV); 2) does not allow exercise in the event of federal or state estate tax; (3) has an ordering provision granting it the priority over highest tax rate assets first; and (4) takes into consideration whether there are assets that likely won’t be sold any time soon. For example, a 90-year-old beneficiary gets a GPOA over stock in XYZ Corp. valued at $2 million with a $1 million tax basis and $1 million built-in capital gain. After TCJA, he will not owe any estate tax because of the increased exemption amount. Thus, the GPOA is exercised, causing the assets to be included in the 90-year-old’s estate, and he gets a step-up in value at death, saving the 20% long-term capital gains tax due on the appreciation. Before TCJA, the asset may have been subject to a 40% estate tax resulting in $800,000 of tax. After TCJA, he is under the exemption amount with no estate tax, freeing the asset up to bring it back into the estate and triggering a basis step-up, saving income tax on the gain of $200,000.
Question: Given that estates now have a high bar for estate taxation, the existence of separate trust legal entities and the income tax consequences of higher brackets must be reviewed and considered in light of the overall changes. Does it make sense to continue to pay higher tax rates inside an irrevocable trust, when the reason for creating the trust – lower estate tax consequences – has been eliminated, even if temporarily?
Answer: For single individuals, the 37% income tax rate applies for taxable income starting at $510,300 and, in the case of a married couple filing jointly, starting at taxable income above $612,350. However, in the case of estates and trusts, the 37% rate kicks in above $12,500. Also, a 3.8% Medicare surtax on “net investment income” is often assessed against individuals and estates and trusts. A state income tax may also be a factor.
The governing instrument of trusts can confer an infinite number of possibilities for distribution powers on a trustee for income or principal. Given the compressed income tax rates and the current framework of income taxation of individuals and trusts, a trustee could make distributions to current beneficiaries to minimize the overall tax impact. While this may result in increased income taxation to the beneficiaries, it will reduce taxation overall of assets in the trust (taxed at a higher bracket). Ironically, the legislation that increased the trust tax rates was designed to do just that.
In the aftermath of the 2017 TCJA, many of the trusts created for tax planning reasons may no longer be relevant or necessary. Under state law, many estate planning professionals and their legal counsel are taking full advantage of opportunities to change the trust by the use of non-judicial settlement agreements; an irrevocable trust may be modified or terminated with the consent of all interested persons as long as the change doesn’t violate a material purpose of the trust. Another technique for changing the income tax status or other unwanted trust provision is taking advantage of the “decanting” statutes available in most states. These statutes allow the formation of a new trust and termination of the old one.
Just as you decant wine by pouring it from its original bottle into a new one, you can pour trust assets from one trust into a new one, leaving the unwanted terms in the original trust.
Passage of the 2017 TCJA, with increasing exemptions and exclusion of tax for estates up to $11.4 million, may be creating more complacency and a lack of interest in planning. Even before the act, most consumers procrastinated and avoided preparation. The bottom line is, laws come and go. Some stay, some go, and some expire. What is constant is YOU! Your needs, wants, and wishes… You need to put an estate plan in place before something happens to you. IF you wait until you are incapacitated, it will be too late for you to make a plan. Take control of your LEGACY and architect it with the help of an estate attorney, wealth advisor, and CPA. Collaborating with other professionals is wise. Saving time and hassle is money well spent. According to one study of why clients don’t sign their estate plans, 95.9% said the plan did not meet their goals, 93.4% said the attorney made me uneasy, and 90.9% said the plan was incomprehensible. Don’t be a statistic. ACT NOW!
Supplemental Graphs and Data
(“Key Elements of the U.S. Tax System”, 2018)
Key Elements of the U.S. Tax System (2018). Tax Policy Center’s Briefing Book. Retrieved from https://www.taxpolicycenter.org/briefing-book/how-many-people-pay-estate-tax
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Mary Ann Hennelly-Favata