Tax Reform: Estate, Gift, and Generation-Skipping Transfer Tax Changes

The Tax Cuts and Jobs Act passed Congress on December 20, 2017 and was signed into law by the President on December 22, 2017 (the enactment date) and is generally effective for tax years beginning after 2017.  This is the eighth and last in a series of articles reviewing some of the more important changes.  This post deals with the changes to estate, gift, and generation-skipping transfer taxes.

Each person has a lifetime basic exclusion that exempts a certain amount from gift, estate, and generation skipping transfer tax.  The gift and estate basic exclusion amounts are unified, but the GSTT basic exclusion amount is independent.  Most taxpayers seek to preserve the basic exclusion amount until death by limiting gifts to the annual gift tax exclusion amount ($15,000 for 2018 gifts) and by using valuation discounts and advanced planning techniques.  On the other hand, wealthy taxpayers are likely to make gifts before death that consume the basic exclusion amount to move future appreciation out of their estates.

The new law doubles (approximately) the basic exclusion amount from $5.6 million per person to $11.18 million for gifts made or deaths occurring in 2018.  This amount is indexed for inflation after 2018 through 2025.  In 2026, the basic exclusion amount is cut in half back to the $5.6 million amount as further indexed for inflation after 2018.  The new law preserves the current law “step-up” (or step-down) in income tax basis of assets owned at death.  Certain deferred income assets do not receive a basis step-up such as 401(k)s or IRAs.

Implications and planning considerations for the increased basic exclusion amount:

·      Wealthy individuals who are or will be subject to estate tax should consider making gifts of appreciating assets up to the new higher exclusion amount as soon as possible.  Early gifting transfers more value out of the estate vs. waiting to make the gift in later years.  There are several giving techniques that can leverage the use of the increased basic exclusion.  While an explanation of the techniques is beyond the scope of this post, such techniques include sales to an intentionally defective grantor trust, grantor retained annuity trusts, charitable lead annuity trusts, discounting the value of business ownership interests, and irrevocable life insurance trusts.

o   For those who have already used these techniques in the past, consider strengthening the tax and economic bona fides of the current structure by gifting more property into the arrangement.

·      There could be a mismatch in exclusion amounts if a person gifts the temporarily high exclusion amount and then dies when the amount of the estate exclusion drops under the sunset provision.  The new law directs Treasury to issue regulations regarding this difference.  Some experts believe that this direction is intended to prevent a “claw-back” of the excess gifting amount at death.

·      Those having estate values less than the temporarily high basic exclusion amount (with husband and wife added together), but more than the old law exclusion amount, should consider waiting until near the sunset date to make gifts of appreciated property.  If there is a death while the exclusion is high, there would not be an estate tax and the heirs would receive an income tax basis step up.  Otherwise, if the property is gifted and then death occurs before the sunset date, the income tax basis would carry over (and therefore the capital gain tax also) to the recipient of the gift.  Gifted assets do not receive an income tax basis step-up.

·      Examine your current estate planning documents that use formulas referencing the basic exclusion amount.  Depending upon the size of the estate, everything could end up in a credit shelter trust.  Benefits for a surviving spouse are often more restrictive in a credit shelter trust than in a marital trust, and this may be particularly true in second marriages.  Such an outcome may not reflect the intentions of the decedent.

·      Think twice about whether the default estate plan of using a credit shelter trust should be use in your estate plan.  Individuals whose estates are no longer taxable under the new law may not want a credit shelter trust, but rather only a marital trust such as a QTIP trust.  The reason why is that upon the death of the surviving spouse, the assets held in the credit shelter trust do not receive a step-up in basis at the second spouse’s death, whereas the assets in the marital QTIP trust do receive a basis step up.  However, under Rev Proc 2016-49, the IRS has authority to disregard a QTIP election if it isn’t necessary to reduce the decedent’s estate tax.  But the IRS will honor a QTIP election if it is made in conjunction with a portability election.  A portability election transfers any unused basic exclusion amount of the first spouse to die to the surviving spouse.  The choice between a credit shelter trust and a QTIP trust does not have to be an either/or decision.  A Clayton-contingent QTIP trust provision in the estate plan creates postmortem flexibility to choose how to allocate estate assets between the two trusts.

·      Examine prior gifting to family LLCs or irrevocable trusts.  Assets in these gifting structures will not receive a full income tax basis step up at death.  Can or should the structures be modified to enable estate inclusion to gain a basis step up?  Does the trust have a power that allows the trustee to substitute outside high basis assets for inside low basis assets?

·      Examine life insurance purchased to pay estate tax.  Does the policy still make sense?  Can the premiums be stopped, and the policy adjusted?  Can the policy be repurposed for other needs?  Before dropping an insurance policy, be sure to consider the temporary nature of the increased basic exemption, and the possibility of adverse estate tax law changes when political power shifts in the future.

·      Should a gift of the increased exclusion be made to an irrevocable life insurance trust to avoid the need for future premium gifts and Crummey notices?

Making sound and lasting financial and estate plans is difficult when tax laws are temporary and political power and philosophies swing back and forth.  But don’t let the temporarily high exclusion amount lull you into inaction.  Even an 80-year-old person has a nearly 50% probability of surviving another eight years, past the 2025 sunset date.  Therefore, a review of your current estate and financial planning goals and plans is advisable.