NEW ESTATE, GIFT AND GST TAX LAWS
On January 1, 2018, the current federal estate tax, gift tax, and generation skipping transfer (GST) tax exemption levels were increased dramatically to $11,180,000 per person ($22,360,000 combined for a married couple). These amounts will increase yearly, as they are indexed for inflation. However, these exemption levels are set to expire and revert back to prior law after 2025, at which time they will be reduced by half. The tax rate will remain at 40% for each of the gift tax, the estate tax, and the generation skipping tax.
It is important to note that no changes were made to the income tax basis rules that apply at death. As a result, individuals will still be permitted to take advantage of the “step-up” (and plan to avoid the “step-down”) in basis that automatically occurs for certain assets included in an individual’s gross estate.
TAX PLANNING OPPORTUNITIES AND PITFALLS
For many individuals, the increased exemptions will eliminate estate tax concerns, at least for now. However, we should stay mindful that even this temporary increase could be derailed before its scheduled expiration by new legislation. Indeed, it is certainly possible that future legislation could cut the exemptions back even to levels considerably lower than those that applied last year.
For individuals facing an estate tax, the temporary increase in exemption levels presents a number of significant tax planning opportunities that should be considered. For example, an individual that had little or no remaining gift tax exemption in 2017 because of significant past gifts, will now be able to make additional gifts of over $5,500,000 without triggering gift taxes (or perhaps double that amount if the individual is married and his or her spouse consents to “split gifts”).
For individuals who are very likely to avoid paying estate tax, there may be opportunities to save income taxes by taking advantage of the basis adjustment rules that apply at the time of an individual’s death. This may involve undoing or modifying trust structures already existing within their plans that were established to avoid an estate tax obligation that was anticipated to arise under the lower exemptions of prior laws. Such modifications, if sensible for tax considerations, would have the added benefit of simplifying existing estate plans by removing tax planning trust requirements and other trust provisions that may no longer be relevant.
The new laws summarized above relate solely to the federal transfer tax system. Many states have their own transfer tax regimes, as well. Fortunately, Florida is not one of those states. However, even Florida residents may be subject to the gift, estate, and GST tax laws of other states, to the extent they own real estate or certain other specific assets within those states. The tax planning features within the estate plan should, in those situations, appropriately address both of those tax regimes. With the great jump in the federal exemption levels, the gap between federal exemption and most state exemptions has become tremendous; and with that, the chances for unintended results under existing estate plan provisions has increased significantly.
While these law changes present significant planning opportunities, they require thoughtful consideration of the individual’s own financial circumstances and tolerance for the applicable risks. Also, please keep in mind that it is not possible to calculate a definite tax result given (i) the possibility of future changes in the tax laws and (ii) the unknown future value of one’s net worth upon death.
SOME PERSPECTIVE ON TAX PLANNING
While adopting an estate plan that minimizes taxation is very important, taxes should not fully consume the focus. For example, many individuals prefer to devise their assets into well-designed, flexible trusts regardless of the potential tax saving elements. Trusts can be used to (i) keep assets in the family, (ii) protect assets from creditor claims and divorce and (iii) facilitate or incentivize desirable conduct and/or circumstances among one’s heirs. Occasionally, the features of an estate plan which most effectively address an individual’s non-tax concerns may not achieve the most tax efficient results, and vice versa. Understanding one’s objectives and priorities is therefore crucial to crafting the most appropriate plan.
REVISIT YOUR ESTATE PLAN
The new tax laws represent a significant change to the prior federal estate, gift and generation skipping tax laws. It is important that you explore the impact of the new tax laws on your estate plan, and address any changes that are necessary to ensure that your documents continue to meet your estate planning goals. Below are a few examples of plans that may need to be updated.
Example 1. The Sleeping Giant Family Trust Directive. A married individual’s current estate plan directs an amount equal to his/her available estate tax exemption to pass into a trust for the benefit of the surviving spouse and descendants (commonly referred to as a “Family Trust”), with the balance of that individual’s assets passing outright to the surviving spouse. Under the new law, the amount passing to the Family Trust per that formula provision will significantly increase and may result in no assets passing to the surviving spouse outright under the residuary clause. This new increased distribution to the Family Trust and reduced outright distribution to the surviving spouse may not match the couple’s intentions.
Example 2. The No-Longer-Needed Family Trust Directive. Under the same basic plan provisions described in Example 1, if the couple’s sole or primary motivation for having directed a Family Trust arrangement for the surviving spouse was to avoid or minimize estate tax upon the second spouse’s death, then they may wish to revise and simplify their estate plans by eliminating or modifying those ongoing trust stipulations that are mandated under their existing documents. A law change in 2013 allowed for portability of the first spouse’s unused estate tax exemption so that it could be added to the surviving spouse’s own exemption. The combination of spousal portability and the new jump in the exemption levels may warrant substantial changes to many existing estate plans.
Example 3. The Surviving Spouse’s New Paradigm – Capital Gain Issues. A surviving spouse is the beneficiary of a Family Trust (estate tax bypass trust) established by his/her predeceased spouse, and there is a strong likelihood that such surviving spouse would still avoid estate tax even if those Family Trust holdings were made part of the surviving spouse’s taxable estate. In such circumstances, it may be beneficial to for the family to consider trying to shift highly appreciated assets with built-in capital gains out of the Family Trust and into the surviving spouse’s taxable estate to achieve a basis step-up (a tax-free cleansing of the gains upon the surviving spouse’s death). Such steps might include a full collapse of the Family Trust in favor of the surviving spouse, or more limited and specific transfers.
Example 4. The No-Longer-Needed GST Trust Directive. An existing plan calls for the creation of lifelong generation skipping trusts for the grantor’s children so that future estate tax exposure can be avoided for the estates of the children upon their later deaths. However, depending on the expected value of a child’s inherited share, and whether the child will already have meaningful wealth of his/her own, the prospect of a particular child facing estate tax exposure may now be quite minimal. Even assuming an outright receipt of his or her inheritance (rather than inheritance through an estate tax avoiding GST trust), the child’s own exemption may well eliminate any estate tax obligation upon the child’s later death. In such a case, the existence of GST trust stipulations for the child’s inherited share may actually be disadvantageous, as compared to an outright bequest to the child.
Example 5. The State Estate Tax Wrinkle. A married individual owns real estate outside of Florida that is not titled jointly between the spouses with rights of survivorship. Formula funding provisions within the individual’s estate plan that are tied solely to a federal tax result, or solely to a state tax result, may yield unintended consequences, since the state and federal taxes and exemptions are not unified.
The above discussion and enumerated examples do not purport to reflect a complete summary of the circumstances that may warrant material changes to one’s estate plan or the risks involved in not exploring such changes.