The Tax Cuts and Jobs Act – How Does It Impact Estate Planning?

Overview

Much of the focus on the new tax law (TCJA) has been on its impact on the rate changes for individuals along with the increase in the standard deduction, and the lower tax rate for C corporations.  Also receiving a great deal of attention has been the qualified business income (QBI) deduction of new I.R.C. §199A. 

But, what about the impact of the changes set forth in the TCJA on estate planning?  That’s the focus of today’s post.

Estate Planning Implications

Existing planning concepts reinforced.  The TCJA reinforces what the last major tax act (the American Taxpayer Relief Act (ATRA) of 2012) put in motion – an emphasis on income tax basis planning, and the elimination of any concern about the federal estate tax for the vast majority of estates.  Indeed, the Joint Committee on Taxation (JCT) estimates that in 2018 the federal estate tax will impact only 1,800 estates.  Given an approximate 2.6 million deaths in the U.S. every year, the federal estate tax will now impact about one in every 1,400 estates.  Because of this minimal impact, estate planning will rarely involve estate tax planning, but it will involve income tax basis planning.  In other words, the basic idea is to ensure that property is included in a decedent’s estate at death for tax purposes so that a “stepped-up” basis at death is achieved (via I.R.C. §1014). 

Increase in the exemption.  Why did the JCT estimate that so few estates will be impacted by the federal estate tax in 2018?  It’s because the TCJA substantially increases the value of assets that can be included in a decedent’s estate without any federal estate tax applying – doubling the exempt amount from what it would have been in 2018 without the change in the law ($5.6 million) to $11.2 million per decedent.  That amount can be transferred tax-free during life via gift or at death through an estate.  In addition, for gifts, the present interest annual exclusion is set at $15,000 per donee.  That means that a person can make cumulative gifts of up to $15,000 per donee in 2018 without any gift tax consequences (and no gift tax return filing requirement) and without using up any of the $11.2 million applicable exclusion that offsets taxable gifts – it will be fully retained to offset taxable estate value at death.  In addition, the $15,000 amount can be doubled by spouses via a special election.  But, if the $15,000 (or $30,000) amount is exceeded, Form 709 must be filed by April 15 of the year following the year of the gift.

Marital deduction and portability.  For large estates that exceed the applicable exclusion amount of $11.2 million, the tax rate is 40 percent. The TCJA didn’t change the estate tax rate.  Another aspect of estate tax/planning that didn’t change involves the marital deduction.  For spouses that are U.S. citizens, the TCJA retains the unlimited deduction from federal estate and gift tax that delays the imposition of estate tax on assets one spouse inherits from a prior deceased spouse until the death of the surviving spouse.  Thus, assets can be gifted to a spouse with no tax complications at the death of the first spouse, and the first spouse can simply leave everything to a surviving spouse without any tax effect until the surviving spouse dies.  This, of course, may not be a very good overall estate plan depending on the value of the assets transferred to the surviving spouse. 

The “portability” concept of prior law was retained.  That means that a surviving spouse can carry over any unused exemption of the surviving spouse’s “last deceased spouse” (a phrase that has meaning if the surviving spouse remarries).  Portability allows married couples to transfer up to $22.4 million without any federal transfer tax consequences, and without any need to have complicated estate planning documents drafted to achieve the no-tax result.  But, portability is not “automatic.”  The estate executor must “elect” portability by filing a federal estate tax return (Form 706) within nine months of death (unless a six-month extension is granted).  That requirement applies even if the estate is beneath the applicable exclusion amount such that no tax is due. 

Remember the “Alamo” – state transfer taxes.  A minority of states (presently 17 of them) tax transfers at death, either via an estate tax or an inheritance tax.  The number of states that do is dwindling -  two more states repealed their estate tax as of the beginning of 2018.  A key point to remember is that in the states where an estate tax is retained, the exemption is often much less than the federal exemption.  Only three states that retain an estate tax tie the state exemption to the federal amount.  This all means that for persons in these states, taxes at death are a real possibility.  This point must be remembered by persons in these states – CT, HI, IL, IA, KY, ME, MD, MA, MN, NE, NJ, NY, OR, PA, RI, VT, WA and the District of Columbia.

Generation-skipping transfer tax.  The TCJA does retain the generation-skipping transfer (GSTT) tax.  Thus, for assets transferred to certain individuals more than a generation younger than the decedent (that’s an oversimplification of the rule), the “generation-skipping” transfer tax (GSTT) applies.  The GSTT is an addition to the federal estate or gift tax, but it does come with an exemption of $11.2 million (for 2018) for GSTT transfers made either during life (via gift) or at death.  Above that exemption, a 40 percent tax rate applies.  Portability does not apply to the GSTT.   

Income tax basis.  As noted above, the TCJA retains the rule that for income tax purposes, the cost basis of inherited assets gets adjusted to the fair market value on the date of the owner’s death.  This is commonly referred to as “stepped-up” basis, but that may not always be the case.  Sometimes, basis can go down.  When “stepped-up” basis applies, the rule works to significantly limit (or eliminate) capital gains tax upon subsequent sale of the asset by the heir(s).   This can be a very important rule for ag estates where the heirs desire to sell the inherited assets.  Ag estates are commonly comprised of low-basis assets.  So, while the federal estate tax won’t impact very many ag estates, the basis issue is important to just about all of them.  That’s why, as mentioned above, the basic estate plan for most estates is to cause inclusion of the property in the estate at death.  Achieving that basis increase is essential. 

Conclusion

Estate planning still remains important.  While the federal estate tax is not a concern for most people, there are still other aspects of estate planning that must be addressed.  This includes having a basic will prepared and a financial power of attorney as well as a health care power of attorney.  In certain situations, it may also include a pre-marital/post-marital agreement.  If a family business is involved, then succession planning must be incorporated into the overall estate plan.  That could mean, in many situations, a well-drafted buy-sell agreement.  In addition, a major concern for some people involves planning for long-term health care. 

Also, it’s a good idea to always revisit your estate plan whenever there is a change in the law to make sure that the drafting language used in key documents (e.g., a will or a trust) doesn’t result in any unintended consequences. 

Oh…remember that the changes in the federal estate tax contained in the TCJA mentioned above are only temporary.  If nothing changes as we go forward, the law reverts to what the law was in 2017 starting in 2026.  That means the exemption goes back down to the 2017 level, adjusted for inflation.  That also means estate planning is still on the table.  The federal estate tax hasn’t been killed, just temporarily buried a bit deeper.