Changes to Estate and Tax Planning Under the TCJA
The Tax Cuts and Jobs Act (TCJA) introduced many sweeping changes, and your clients likely have questions regarding their current estate planning strategies. By taking a deeper dive into the TCJA, you can identify potential issues in their existing plans, plus identify unique opportunities.
Here, we’ll explore changes to estate and tax planning under the TCJA, beginning with the new exemption levels.
New Exemption Levels
Under the TCJA, the estate and gift tax exemption increased from $5 million to $10 million per taxpayer. The $10 million exemption also includes a retroactive inflation adjustment that brings the total amount to approximately $11.2 million per person or $22.4 million per married couple.
Let’s look at some examples to help illustrate how this increase could affect clients differently.
John and Mary
Living a comfortable retirement in New Hampshire, which has no state-level transfer taxes, John and Mary are 70 years old. Their estate has remained at $4 million since they created their estate plan 15 years ago. They have strong long-term care policies to protect their assets from an extended health care event. Their assets are held in a joint revocable trust, which will split into an AB trust at the first death. The bypass trust (B trust) will be funded up to the federal exemption, and any remaining assets will go to the A trust. The exemption amount when they created their plan was $1 million, and there was no portability.
Since the federal exemption amount is now $11.2 million per spouse, it’s unlikely that this couple will ever be subject to federal estate tax. Because of the B trust’s mandatory funding provision, however, the entire $4 million estate will end up in the B trust. The surviving spouse’s access to these assets will have restrictions. Further, the assets will not receive a step-up in basis when the second spouse dies.
The opportunity. Add value by bringing these issues to the couple’s attention. Once they understand that the current design could be problematic, you might bring in an estate planning attorney to discuss possible adjustments. Also, the trust could be redrafted to provide more flexibility in addressing the loss of control and loss of step-up in basis at the second death. One solution may be a joint trust that remains revocable until the second death. This way, the surviving spouse has no loss of control over the assets and will receive a step-up.
Elsie and Nelson
Also 70 and living in New Hampshire, this high-net-worth couple has an estate worth $25 million. They live primarily on their income from private-sector pensions and social security. They used their combined lifetime exemption to gift $10 million to an irrevocable trust in 2011.
These clients decided to use their lifetime exemption for lifetime gifts rather than save it until death and use it against estate taxes. This is a common strategy for wealthy individuals. What they accomplish is removal of subsequent appreciation on the $10 million from their estate. Considering they made the transfer in their early 60s, the $10 million could be worth substantially more by the end of their lifetimes.
The opportunity. The new tax law provides these clients with the opportunity to compound the power of this strategy by using the increased exemption amount. The combined $22.4 million exemption means they could transfer the unused $12.4 million. Considering the clients have a large estate and live modestly off their fixed income, removing some or all of the newly available exemption amount may make sense.
Some of the new law’s provisions sunset in 2025, when the lifetime exemption amount will revert to $5 million plus inflation adjustments. This has led some to question whether there will be a claw-back affecting individuals who maximize lifetime gifts up to the $11.2 million before the sunset. The act itself calls for guidance to address the potential claw-back, so most experts are confident there won’t be one.
Lifetime Gifting Strategies
Valuation discounts. For wealthy business owners, using strategies that maximize the value of the gift tax exemption through discounting is still viable. Family limited partnerships or LLCs allow valuation discounts on the transfer of business interest to the limited partners. These valuation discounts lower the impact on the transferor’s lifetime gift exemption. Taxpayers can transfer business interest exceeding the $11.2 million gift exemption without incurring any gift taxes.
Trusts with swap power. Another concern for taxpayers who have used lifetime gifting strategies is the loss of step-up in basis at death. One solution is to use an intentionally defective grantor trust (IDGT) with a substitution or swap power to hold the gifted assets.
All transfers to the IDGT are completed gifts to the trust beneficiaries, but the grantor is responsible for any tax liability generated by the assets. This allows the trust assets to grow without any drag from taxes while also sheltering appreciation from estate taxes, as the IDGT assets are removed from the grantor’s estate.
The swap power allows the grantor to reacquire the assets transferred to the trust by substituting property of equivalent value. This brings the appreciated assets back into the estate where they will receive a step-up in basis. The trust is left with the cash, and the tax liability on the appreciation is eliminated.
Charitable Giving Considerations
Another major provision of the TCJA increases the standard deduction to $12,000 for single filers and $24,000 for joint filers. This change, coupled with limitations on state and local tax and miscellaneous deductions, will cause a higher number of taxpayers to take the standard deduction rather than itemizing.
One effect of this is likely to be a major reduction in the number of taxpayers who can deduct their contributions to charitable organizations (an itemized deduction). This change is significant because it eliminates an important financial incentive to giving.
Some clients may want to stagger years where they itemize and years where they take the standard deduction. They could hold funds slated for charitable giving for two years so that they maximize what they can deduct. Or, they could accelerate other itemized deductions (e.g., medical expenses) into the same year. (Under the TCJA, the threshold for deducting medical expenses is reduced to 7.5 percent for 2017 and 2018. This threshold goes back to 10 percent in 2019.)
Take a Deeper Dive to Add Value
Of course, you can never have all the estate and tax planning answers. But you can add value by educating your clients on the issues they should consider. So, take a deeper dive into the benefits and pitfalls of the TCJA—and find the estate and tax planning opportunities your clients are looking for.