Wealth Planning Update - Revisiting Your Estate Plan in the New Tax Environment - The Private Bank - Wells Fargo

In this Wealth Planning Update:

  • The Tax Cuts and Jobs Act doubled the estate, gift, and generation-skipping exemption.
  • It is important to review and discuss the appropriateness of current estate plans in light of tax reform.
  • Consider making lifetime gifts to “lock in” the increased exemption amounts.

Download the report (PDF)

On December 22, 2017, the president signed the Tax Cuts and Jobs Act (the act), the most significant change to the Internal Revenue Code since 1986, into law. The act doubled the estate, gift, and generation-skipping transfer (GST) exemption amounts, meaning individuals have a window of opportunity to transfer $11,400,000 in assets without tax consequences. This window is set to “sunset,” or close, on December 31, 2025. Depending on the outcome of elections in upcoming years, it’s possible this may change sooner.

This Wealth Planning Update discusses potential estate planning opportunities in light of the act as well as why it’s important to review existing estate plans, even if you don’t believe you will be subject to federal estate taxes under the new law.

New Estate, Gift, and GST Tax Environment

Under the law:

  • The estate and gift tax “applicable exclusion” is $11,400,000 per person ($22,800,000 for married couples, with proper planning) in 2019. This amount will be adjusted for inflation in future years.
  • The GST tax exemption is increased to the same level, adjusted for inflation.
  • The estate, gift, and GST tax rate continues to be a flat 40%.
  • The annual gift exclusion amount is $15,000 per beneficiary for 2018, also adjusted for inflation.
  • The “portability” election, which lets a surviving spouse make an election to utilize the deceased spouse’s unused estate tax applicable exclusion amount, is still available. Note: Portability does not apply to an unused GST exemption.

Under the act, the increases in the applicable exclusion amounts are scheduled to revert back to 2017 levels ($5,490,000, adjusted for inflation) in 2026. This means there is a limited time period to take advantage of the increased amounts that can pass free of estate, gift, and GST tax.

Lifetime Gifting Opportunities in Light of Tax Reform

The act’s doubling of the estate, gift, and GST tax exemptions offers various planning opportunities for individuals who plan to make either large lifetime gifts in the future or after their death. To lock in the increased exemption amount, you should work with your advisors to identify lifetime gifting opportunities before the act’s provisions sunset. There are a variety of options available, but the appropriateness of each should be discussed with your advisors based on your specific circumstances.

Spousal Lifetime Access Trust

You may be reluctant to make lifetime gifts to an irrevocable trust because, for example, of the loss of control over the contributed assets or a concern that it will deplete your funds to a point where you will no longer be able to maintain your accustomed standard of living. Using a spousal lifetime access trust (SLAT) may alleviate these concerns for married couples. A SLAT is a form of irrevocable trust that is funded during the donor’s lifetime using annual exclusion gifts, applicable exclusion gifts, and/or taxable gifts.

A SLAT lets a donor spouse make a gift to an irrevocable trust in which his or her spouse is named as the lifetime beneficiary. A gift to a SLAT constitutes a completed gift, thus removing both the asset and any future appreciation from the donor spouse’s estate while still providing access to the assets through the beneficiary spouse for as long as they remain married. As a result, SLATs can be a powerful tool to capture the increased exemption amount without losing access to the gifted assets

Grantor Retained Annuity Trust

A grantor retained annuity trust (GRAT) is a technique that allows for the appreciation of trust assets being excluded from the donor’s estate and the assets transferred to family members with minimal tax implications. GRATs may be funded with a wide variety of assets, including marketable securities, closely held business interests, private equity, or hedge funds, and can be structured to produce little to no taxable gift.

Since GRATs are grantor trusts, there is a potential income tax advantage to funding them as the donor will be responsible for paying the taxes on all income items attributable to the trust property on their personal income tax return. Tax payments will further reduce the donor’s estate while the assets potentially grow tax-free. Thus, with income tax rates remaining low and the availability of additional lifetime exclusion amounts, one may want to consider placing appreciating assets into GRATs to remove them from a taxable estate.

Forgiveness of Promissory Notes From Previous Transactions

If you have any promissory notes from previous transactions, you may want to consider forgiving them in order to use the additional exclusion amount the act provides. The forgiveness of a note is considered a taxable gift, yet the asset transferred and/or money lent is out of the taxable estate and the additional exclusion is captured before it is set to sunset in 2025. You should discuss outstanding promissory notes with your advisors to determine whether this is an appropriate way to use this exclusion.

Charitable Giving

While making lifetime gifts to charitable organizations does not use your lifetime exclusion, it does provide a means for shifting assets out of your taxable estate as well as potentially providing income tax savings. With the standard deduction increasing to $12,000 and $24,000 for individuals and married couples (filing jointly), respectively, it is assumed that fewer people are likely to itemize deductions. However, larger donors, especially those with higher incomes, may continue to benefit from itemized charitable deductions.

You may consider grouping several years’ worth of charitable contributions into a single year to help increase income tax savings. This can be done through a one-time lump sum gift to a qualifying charitable organization or a large gift to a donor advised fund, which can then be distributed over several years. Further, if you are charitably inclined and at least 70½ years old, you have the option to make charitable contributions of up to $100,000 per year directly from your IRA, which will be excluded from your gross income (but not available as a charitable deduction).

Planning Opportunities With Respect to Current Estate Plans

Reviewing Current Estate Plans

While the increased exemptions mean fewer people will be subject to federal estate taxes (at least until 2026), it may also result in current estate plans having unintended consequences. Now is the time to revisit estate planning documents, even if they were prepared recently, to ensure they are tax-efficient and help achieve your planning objectives.

Managing Tax Basis

A key discussion of gifting during life versus bequeathing assets is that of the step-up in cost basis. When a gift is made, the asset’s cost basis is carried over to the recipient. However, if held until death, the asset’s basis is stepped up to the fair market value at the time of death. Given the larger gift exemption now available, additional attention should be paid to tax basis when reviewing existing estate plans.

If you have previously gifted assets with low income tax basis to irrevocable trusts, those assets will not receive a step-up in basis upon your death. If the trusts include power of substitution provisions, you should now consider substituting high-basis assets.

Rethinking ‘Credit Shelter’ Trusts

Many plans for married couples call for automatic maximum funding of a “credit shelter” or “bypass” trust at the first spouse’s death using a formula based on the applicable exclusion amount. Unless the plan is updated, this could result in less-than-optimal use of the deceased spouse’s exclusion and sacrifice the opportunity for a step-up in cost basis at the surviving spouse’s death. In some instances, the credit shelter trust is intended to benefit children rather than, or in addition to, the spouse with any additional assets going outright to the surviving spouse or a marital trust. The increased exemption may result in all or a majority of the assets being used to fund the trust with little or no assets left to the surviving spouse.

Effectively Utilizing the GST Exemption

For married couples, any unused GST exemption is typically allocated on the death of the first spouse to die by bequest of the estate applicable exclusion amount. Because the GST exemption is not portable, if the gift of the estate applicable exclusion amount is limited to what can pass without incurring state estate taxes, a portion of the GST exemption might be wasted. You may want to consider allocating any remaining GST exemption to a trust for the surviving spouse that will qualify for the marital deduction.

If you have both GST-exempt and nonexempt trusts, consider allocating your GST exemption to trusts that are currently nonexempt, including trusts created at the termination of qualified personal residence trusts (QPRTs) or GRATs or irrevocable trusts created when the GST exemption was much lower.

Reviewing Titling of Assets

As you review your estate plan, pay close attention to the titling of your assets. For married couples, depending on the provisions of their estate plan, each spouse should have sufficient assets in his or her name to fully utilize the estate and GST exemptions at death.

Remembering State Estate Taxes

A number of states, like New York and Connecticut, are “decoupled” from the federal estate tax regime, meaning that their applicable exclusion amounts do not match the federal amounts. Estate plans should be reviewed to make sure gifts of the federal applicable exclusion amount will not result in a state estate tax being due upon the first spouse’s death.

Now What?

The act represents a significant change to estate, gift, and GST tax law. Its impact will affect every taxpayer differently, and as a result, these provisions require careful consideration.

Contact us to discuss working with the Wealth Planning Specialist in your market, as well as your estate planning attorney and tax advisor, to help determine what action steps may be appropriate for you.

Authors: Catrina Crowe, Senior Wealth Planning Strategist and Nicole Kianka, Wealth Planner