Estate, Gift and Generation Skipping Transfer Tax Changes Under the Tax Cuts and Jobs Act (the “Act”)
The Act made a significant change in the basic applicable exclusion from estate and gift taxes (“applicable exclusion”) available to each individual. The applicable exclusion is now doubled from $5,000,000 to $10,000,000 per person and is indexed for inflation. In 2018, the exclusion is anticipated to be set at approximately $11,200,000.
The Act also made a significant change in the generation skipping transfer tax exemption (“GST exemption”) available to each individual. The GST exemption is now doubled from $5,000,000 per person to $10,000,000 per person and is indexed for inflation. In 2018, the exemption is anticipated to be approximately $11,200,000.
The increased exclusion and GST exemption are both temporary changes and will expire on December 31, 2025 and revert to 2017 levels, adjusted for inflation.
Notably, the Act did not change the statutory provisions related to basis of property acquired from a decedent. Property inherited from a decedent will still receive an adjustment in basis to its fair market value at date of death. Although this is typically referred to as a “step up in basis”, it is technically an “adjustment to basis” and basis in inherited assets could be decreased if fair market value at date of death were less than the cost or adjusted basis before death.
Portability of the applicable exclusion was not affected by the Act. The GST exemption remains non-portable.
Because the doubling of the applicable exclusion and GST exemption is temporary, taxpayers should consider using the increased applicable exclusion and GST exemption on lifetime gifts while the larger exclusion and exemption is available.
While the new Internal Revenue Code Section 2001(g)(2), together with the accompanying Conference Committee Report, indicates that the Secretary of Treasury is to issue regulations addressing the potential disparity between the estate tax exemption in effect at the death of the decedent and the lifetime gift exemption in effect at the time gifts are made by the decedent, to carry out the purposes of IRC Section 2001, neither the new Section 2501(g)(2) nor the Conference Report provides any indication of exactly what these “purposes” are. While it is conceivable that Treasury regulations might be proposed which would result in a “claw back”, or a requirement that gifts made under the increased applicable exclusion during life be brought back into the estate if the applicable exclusion is smaller at time of death, it is likely that any such regulations would be subject to multiple challenges.
There may be an additional tax benefit to the large gifts for individuals residing in states that impose an estate or inheritance tax, but which don’t effectively impose a tax on lifetime transfers. For example, Nebraska imposes an inheritance tax on assets held at death but not a tax on lifetime transfers made more than three years prior to the date of death.
Lifetime gifts do not receive a step up in basis to value at date of death, but certain strategies can be used in gift trusts subject to powers of appointment so that a step up in basis to the fair market value upon the surviving spouse’s death can be achieved.
Use of the temporarily increased GST exemption on lifetime gifts also should be considered by those wishing to pass down wealth to generations beyond their children. Once the GST exemption has been applied to a gift in trust to give that trust a zero inclusion ratio, the trust, so long as it is properly managed and maintained, can appreciate and grow without being subject to generation skipping tax. Distributions from the trust can be made to beneficiaries over multiple generations.
Many estate plan documents have, in the past, been drafted with “formula” allocations so that property equal to the applicable exclusion amount is allocated into an “exclusion trust” (sometimes known as a unified credit trust or a family trust). Taxpayers should review those provisions now and decide whether this division of assets which could allocate up to $11,200,000 to an exclusion trust corresponds with their testamentary wishes.
There are a number of variations to a formula plan which may be considered. One such variation is a plan by which a decedent leaves all property to his surviving spouse but gives his spouse the ability within 9 months after the death of the decedent to disclaim the property into an exclusion trust. The temporary increased applicable exclusion, portability, and step up in basis rules allow taxpayers several alternative ways to establish their estate plan. Now, more than ever, no one plan fits all.
Effective wealth transfer techniques such as GRATS, sales to grantor trusts, AFR interest loans, irrevocable trusts, irrevocable life insurance trusts, opportunity transfers, formation of family limited partnerships and limited liability companies and utilization of discounted valuation techniques are all still available strategies and should be considered in appropriate cases.