Tax Act of 2017: Transfer Tax Provisions
The Tax Cuts and Jobs Act of 2017 (the “Tax Act of 2017”) was signed by the President on December 22, 2017. The transfer tax provisions of the Tax Act of 2017 (i.e. the estate, gift and generation-skipping transfer (“GST”) tax provisions), among others, are effective for taxable years starting January 1, 2018, but are set to expire after December 31, 2025.
Under the Tax Act of 2017, the estate, gift and GST tax exemptions are increased from $5 million to $10 million (indexed for inflation). As stated above, the increased exemptions are currently effective for tax years 2018 through 2025, meaning that in 2026 the estate, gift and GST exemption provisions under the Tax Act of 2017 would sunset and return the amounts to those as calculated under current law.
The effective exemption amount for estate, gift and GST tax as of January 1, 2018, is set at approximately $11.2 million per person, which is a substantial increase from the $5.49 million exemption amount for estate, gift and GST tax as of December 31, 2017. To provide some further perspective of the significance of these provisions, think back to 2003 when the estate tax exemption was $1.5 million, and if a decedent owned a life insurance policy in his or her name with a death benefit in excess of $1.5 million, then he or she automatically had an estate tax issue, which in turn led to the creation of many irrevocable life insurance trusts, many of which were no longer necessary when the estate tax exemption amount was permanently set at $5 million (indexed for inflation) by the American Taxpayer Relief Act of 2012.
With the transfer tax provisions of the Tax Act of 2017 set to expire at the end of 2025 if no further action is taken, concern may arise regarding a decedent who makes a gift prior to 2025 that is covered by the gift tax exemption amount during his or her life, but upon such decedent’s death after 2025 the gifted amount is in excess of the then existing estate tax exemption amount. In such an instance, the question is whether the gift will be clawed back into the decedent’s taxable estate and made subject to the estate tax. The Tax Act of 2017 states that the Treasury Secretary may issue regulations to avoid a clawback, but the concern remains until such regulations are issued.
Impact of the Tax Act of 2017 on Estate Planning
The transfer tax provisions of the Tax Act of 2017 will have a significant impact on estate planning. Issues of importance to review and discuss include those surrounding transfer taxes, income tax, and general estate and trust non-tax considerations. Below is a list of some of those issues, taking into account that the new transfer tax provisions are scheduled to sunset at the end of 2025.
- While the exemption for each individual is at least $11.2 million (between 2018 and 2025), should individuals who would be subject to federal estate tax after 2025 make significant gifts to family members or trusts for the benefit family members. If a trust is preferred, the donor will need to decide whether to create the trust as a grantor trust for income tax purposes, as well as whether to create a generation-skipping trust for tax and non-tax purposes.
- Many estate plans of individuals and spouses can be simplified because of the high transfer tax exemption amounts. In light of this opportunity to simplify, should spouses merely leave assets to the survivor outright and free of trust, or should they plan to hold the assets in trust for the benefit of the survivor.
- Formula clause in revocable trusts should be reviewed. An example of a typical formula clause in a trust is where trust property is allocated upon the death of the grantor, or upon the first death of a grantor in regard to a joint trust, first to the credit shelter trust in an amount equal to the maximum amount possible without incurring any estate tax, with the balance being allocated to the marital deduction trust. Unintended consequences could result with the use of such a formula clause, and it may be advisable to consider the use of a disclaimer trust or a trust that can elect to be treated as a QTIP trust in whole or in part, both of which provide greater estate tax and income tax planning flexibility.
- With the increased transfer tax exemption amounts, resulting in transfer taxes becoming irrelevant for many people, should the estate plan provide more of a focus on income tax planning and techniques, for example to ensure the maximum step-up in basis is achieved upon death, and in the case of a married couple upon the death of the first decedent as well as upon the death of the survivor.
- Should other non-tax considerations be revisited in connection with consideration of tax issues, such as trustee selection, beneficiary designation and distributions, the use of powers of appointment, as well as creditor and spousal protection.
The uncertainty that we are set to experience with the Tax Act of 2017, although maybe on a smaller scale in some ways since the current exemption amounts are substantial, is reminiscent of the uncertainty experienced with The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which reduced transfer taxes significantly, but only through 2010, whereupon the estate and GST taxes were repealed entirely for 2010, leaving only the gift tax (at a reduced rate) in effect that year.
The laws that affect estate planning are ever changing. In light of the numerous adjustments made by the Tax Act of 2017, as well as the uncertainty the looms because many of the provisions may expire at the end of 2025, it is important for people to sit down and review their existing estate plans to ensure those plans continue to satisfy tax and family-related objectives, while building in as much flexibility into the plan as possible.