An estate plan is like a car or a house: It needs regular maintenance to function as intended. Yet unlike your car or home, external events can create the need for adjustments. Among such events is legislation like the tax bill Congress passed in late December.
So this is an important time to schedule a meeting with your estate planner and be certain your plan is up-to-date. Even if your estate plan won’t be affected by the new tax law, it’s smart to confer with your estate planner periodically to be certain your current wishes are reflected in your estate planning documents.
As I explained when it passed in December, the new tax laws effectively eliminated any estate tax for the vast majority of families.
According to Pat Rufolo, Chairman of the Private Client Services Group, McElroy, Deutsch, Mulvaney & Carpenter, LLP, “For families who no longer have to pay federal estate taxes, revisiting their estate plans is probably a very good idea. In working with our clients who no longer need to pay this tax, we’re seeing many ways to make their estate plans more efficient, less complicated, and considerably less costly for their families in the long term.
I have started writing every client in which I did advanced estate tax planning. I am suggesting that they need to consider modifying the estate planning we previously did. The trusts and planning may not only prove useless for tax savings now, but it may actually encumber the surviving spouses freedom unnecessarily. To review:
The changes can be summed up very succinctly: The estate, gift and generation-skipping transfer tax exemptions have doubled. Under the law, and beginning in 2018, each individual can pass approximately $11.18 million during life, at death, or in some combination thereof free of estate, gift and generation-skipping transfer tax. Married couples can transfer approximately $22.36 million. These amounts will increase annually for inflation. . .
The increases in exemptions only last until December 31, 2025. After that, and barring future legislative action, exemption amounts return to 2017 levels (with intervening annual inflationary adjustments).
While I think Congress will act, this article brings out an additional point for why these formerly effective and proper planning techniques are no longer best.
With the dramatic increase in estate tax exemption since 2012 (including under the new law), this type of plan may cause all assets of the first to die to pass to the Bypass or Credit Shelter Trust. From an estate tax planning perspective, that still works. But that plan does not maximize income tax planning because the Bypass or Credit Shelter Trust will not be included in the surviving spouse’s estate, thereby missing an opportunity for a second step-up in basis and not eliminating income tax on the appreciation since the first death. There may be recommended changes to your plan that allow for maximum estate and income tax planning and accommodate the future reversion to the 2017 law.
However, your estate plan still needs to invoke proper language:
To assure that exemption limits from the estate of a deceased spouse are portable, estate planning documents of the surviving spouse must correctly invoke portability, using the right language. Otherwise, the estates of these spouses might be forced to create something known as a bypass trust — a costly, time-consuming route that can have the effect of reducing the amounts that heirs ultimately receive.
Not everyone agrees with my assessment, here is one counter-argument.
- The amount that you can transfer tax-free, during life or at death, has doubled, from $5 million to $10 million per person, indexed for inflation after 2011. Depending on how inflation is calculated, the exemption for 2018 could be as much as $11.2 million ($22.4 million for married couples). If you exceed the limit, you (or your heirs) will owe tax of 40 percent.
- As in the past, there is an unlimited deduction from estate and gift tax that postpones the tax on assets spouses inherit from each other until the second spouse dies. This marital deduction, as it is called, applies only if the inheriting spouse is a U.S. citizen.
- Widows and widowers can carry over any unused exemption of the spouse who died most recently and add it to their own. Portability (as tax geeks call it), which started for deaths in 2011, currently allows married couples (whether the spouses are same-sex or heterosexual) to transfer as much as $22.4 million together tax-free. To take advantage of this option, or “elect portability” (in legal lingo), the executor handling the estate of the spouse who died must file an estate tax return (IRS Form 706), even if no tax is due. This return is due nine months after death, with an automatic six-month extension allowed. Though you can request additional time
after that, it’s much better to mark your calendar and make sure the executor meets the deadline. . .
- Anyone can give another person $15,000 per year without it counting against the lifetime exemption discussed above. (The amount, which is adjusted for inflation, went up in 2018, from $14,000, where it had been for the previous five years.)
Spouses can combine this annual exclusion to double the size of the gift. Don’t confuse this with the gift-tax exemption – that $11.2 million discussed above . . . But do note that if your annual exclusion gift to anyone exceeds $15,000, you must report that gift on Form 709 – the gift-tax return that’s due in April of the year after you make your gift.
- Generation-skipping transfer tax applies, on top of estate or gift tax, to assets given to grandchildren (or to trusts for their benefit). But here, too, the law offers an exemption of as much as $11.2 million (indexed for inflation), whether the transfer is made during life or at death, before a 40 percent levy applies. There is no portability for this tax, but for transfers during life married couples can combine each of their exemptions to give away a total of $22.4 million.
- For income tax purposes, the cost basis of inherited assets gets adjusted to the fair market value on the date of the owner’s death. This limits the capital gains tax inheritors must pay if they sell the property. Unlike the estate tax exemption, which now concerns only very wealthy people, capital gains tax affects all of us.
- Sunset provisions: In 2026 all the numbers highlighted above, except for the annual exclusion, revert to the rates in effect in 2017, adjusted for inflation.