Tax Reform and Estate Planning Under the 2017 Tax Cuts and Jobs Act

Authored by: John M. Jolley, Sherri L. McGirt, and Jennie Cerrati

When the 2017 Tax Cuts and Jobs Act was passed, significant changes were made to the Federal Estate, Gift and Generation Skipping Tax, the most prominent of which is the increased applicable exclusion amount, which is the amount that is excluded from a decedent's gross estate for federal estate tax purposes. The applicable exclusion amount was $5.49 million for decedent's dying and gifts made in 2017. This amount is doubled for decedent's dying and gifts made after 2017 and before 2026. It is currently $11.18 million and will continue to be adjusted for inflation.

This generous increase in the exclusion amount is scheduled to revert to the 2017 exclusion amount on January 1, 2026.

A decedent's estate may elect to transfer any unused portion of the decedent's exclusion amount to the surviving spouse. This election is referred to as the "portability" election. If the surviving spouse is the sole beneficiary of the decedent, the decedent's estate could transfer up to $11.18 million to the surviving spouse in 2018, enabling the spouse to shelter more than $22 million at the subsequent death.

The increased exclusion amount may drastically alter the intended results of current estate plans, particularly older plans that have not been updated after 2012. Because of the increased exclusion, everyone should review their current estate plan taking into consideration several items listed below:

  • Review trust agreements and look for formula clauses tied to the exclusion amount. These clauses attempt to fully utilize any unused exclusion amount that may be available at death by allocating assets to a trust or to a specific non-spouse beneficiary. This situation could occur after significant life time gifts have been made, with the intent to utilize the remaining exclusion amount as a further gift at death. Another common plan is to first allocate the available exclusion amount to a "family trust" or 'by-pass trust", designed to benefit numerous beneficiaries, with any remaining funds passing outright to or for the benefit of the surviving spouse.

As a reminder, the exclusion would have been $675,000 in 2001, $1.5 million in 2005 and $2 million in 2008. Because of the increased exclusion amount, the existing formula provisions could divert all assets to the non- spouse beneficiary or to the "family trust", thereby unintentionally limiting assets available to transfer to or for the benefit of the spouse.

  • Review trust agreements to simplify estate plan. In the past, many plans used the "family trusts" or "by -pass" trusts referred to above in order to reduce federal estate taxes. With the increase in the exclusion amount, there may be no need to use this type of trust, creating an opportunity to simplify the estate plan. This type of trust may even be a disadvantage due to the income tax consequences to beneficiaries inheriting assets from this trust. Assets distributed at the death of the lifetime beneficiary do not receive an adjustment in income tax basis when these assets pass on to the remaindermen.
  • Review net worth and character of assets. Over the years, your net worth may have changed significantly or you may have changed how assets are owned, or sold or acquired assets that weren't accounted for in your original estate plan. If the value of your assets have changed significantly or the types of assets you own are concentrated in illiquid assets, you may now require planning for disposal of these assets at death or the use of ownership entities to manage for future generations. In addition, The 2017 Tax Cuts and Jobs Act included income tax changes that impact the choice of entity for business operations. Prior to this act, the choice of entity for small business owners was generally a "pass through" entity such as a partnership or limited liability company that was not taxed separately for income tax purposes, but passed through earnings to be taxed at the individual level. Due to the change in corporate tax rates and the implementation of the qualified business income deduction for certain qualifying business, the use of a regular corporation as an entity may be a more appropriate choice in the new tax environment and should be planned for accordingly. The use of a corporation may also offer more options in estate planning, enabling more flexibility in using various trusts to own these assets.
  • Consider Trusts for other purposes. While the use of trusts solely for tax planning may not be not be as important under the 2017 Tax Cuts and Jobs Act for many individuals, there are a myriad of other reason why certain trusts may be useful. They may be used to protect assets for children or grandchildren, to manage assets for the disabled or elderly or to establish charitable gifts. In reviewing your plan, your goals or the original purpose of your plan may have changed. Your new goals should be coordinated with the new tax structure.
  • Plan for changes in the Federal Gift Tax. In addition to the changes in the Federal Estate Taxes, there have also been changes to the Federal Gift Tax. You may use your federal exclusion amount of $11.18 million to shelter large gifts. What is not used during lifetime is available to shelter bequests at death. The annual exclusion amount available for gifts to an individual in one year is now $15,000 per donee. Spouses together can make gifts of up to $30,000 per donee without using any of the federal exclusion amount. An easy gifting strategy of the use of the annual exclusion amount can transfer significant wealth over time. In addition, for some of the wealthier clients, a gift of $11.18 million may be a useful strategy considering that the exclusion amount may revert back to $5 million, in 2026. If that is the case, such a gift would effectively remove the excess over the estate exclusion amount from being taxed. However, it is not clear if the IRS will adopt regulations that gifts would first use exclusion from the excess portion. If not, a large gift may be the most prudent way to insure the full use of the exclusion before it reverts back to the lower amount.
  • Review Beneficiary Designations. It is important to review the beneficiary designations on your life insurance and retirement plan accounts to insure that they still coordinate with your overall estate planning goals.
  • Review the impact of miscellaneous income tax changes.
  1. Kiddie Tax. A "kiddie tax" has long been imposed on a child's unearned income taxing such income at the parent's rate. This tax applies to children under 19 and college students under 24. The 2017 Tax Cuts and Jobs Act now taxes the unearned income at the applicable trusts and estate tax rates. A child's unearned income over $12,500 will be taxed at 37% which can be higher that the parent's rates.
  2. Qualified Tuition Plans or 529 Plans. A QTP or otherwise known as a 529 Plan may be established for a designated individual to pay his or her qualified education expenses. These plans are generally established by the states, or a state agency. Gifts to these plans qualify for the gift tax annual exclusion amount but are not generally deductible for federal income tax purposes. Contributions may be deductible for South Carolina income tax purposes but not North Carolina, for example. Distributions from the QTP are not included in income of the designated beneficiary to the extent the distributions are used to pay qualified education expenses. The Tax Cuts and Jobs Act has added a provision that allows up to $10,000 to be distributed annually for tuition expenses at private or religious K-12 schools. This change in law allows individuals paying for private or religious tuition for grades K-12 to make distributions from a 529 plan now, as opposed to having to wait until their children attend a higher education school.
  3. Cash Contributions to Charities. Individuals may deduct gifts to charity if they itemized deductions. The amount is limited by a percentage of Adjusted Gross Income (AGI). The old law limit was 50% of AGI for a qualified charity. The new law is now 30% of AGI for cash contributions.
  4. Standard Deduction. The standard deduction has been increased to $12,000 for an individual and $24,000 for marital couples. This change may impact the amount of future charitable contributions since many taxpayers may not be required to itemize deductions.
  5. Income Tax Basis. Because of the significant increase in the federal exclusion amount, most individuals will not have to plan for paying estate taxes. However, the focus on income taxes becomes more important. Assets included in a decedent's estate receive an adjustment in income tax basis to the fair market value as of the date the decedent's death. When these assets are sold by the heirs, the capital gain is computed only on the appreciation occurring after the date of death. In view of the elimination of federal estate tax for many taxpayers, the income tax planning becomes paramount and the preservation of the "step up" in income tax basis becomes the focus of many estate plans.

It has now been six months since the Tax Cuts and Jobs Act has been in effect, with many questions still unanswered until further IRS regulations are implemented. Nevertheless, the known impact on estate planning is significant and requires immediate attention.

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