The Tax Cuts and Jobs Act (the “Act”) was signed into law on December 20, 2017, with an effective date of January 1, 2018. The Act doubled the exemption amounts for taxpayers for estate, gift, and generation skipping transfer taxes. The exemption amounts are now $11,200,000 per person and $22,400,000 per married couple. The exemption amounts will increase each year based on inflation. The increased exemption amounts under the Act, however, will only exist through December 31, 2025. Unless the law is amended, the increased exemption amounts will “sunset” on January 1, 2026 to their pre-2018 levels (adjusted for inflation). The Act did not amend the tax rate for estate, gift, and generation skipping transfer taxes, which remain at 40%.
For clients who are business owners, the Act may or may not impact the execution of the succession plan for the family business. In general, succession planning should be framed more by planning to achieve long term success for the business than by tax avoidance. For example, the importance of developing next generation leaders is not impacted by the tax laws. However, the Act does present unprecedented opportunities for planning. Some considerations for clients:
Clearly, the increased exemption amount allows for more significant lifetime gifting of business interests. For those clients engaged in gifting of business interests, you may want to consider a more significant gift or gifts in the next few years.
Although not directly related to succession planning, clients should consult with their accountants to confirm whether the structure of the business and the compensation paid to its owners is optimized under new section 199A of the Code (the new section that provides an income tax deduction for “pass through” businesses).
For clients who have trusts that own business interests, consideration should be given whether to restructure the trusts to ensure an income tax basis step up upon the death of a beneficiary. Trusts are generally designed so that the assets of the trust are not included in the beneficiary’s taxable estate (to avoid estate tax). However, trust assets do not get an increase in cost basis when the beneficiary dies. If the beneficiary will not be subject to estate tax, it may make sense to trade the Pennsylvania inheritance tax at the rate of 4.5% for children to avoid the capital gains tax on built-in gains.
For clients with grantor trusts, consideration should be given to substituting high cost basis assets with low cost basis assets.
With respect to life insurance, clients should review their life insurance portfolio to ensure that the amount of life insurance backing buy-sell obligations is adequate. Likewise, clients should review life insurance policies to make sure the amount of coverage is adequate, that the policy is performing as illustrated, and to evaluate whether an exchange of policy is warranted. In the case of Irrevocable Trusts, it may be possible to reduce the death benefit in exchange for lower (or no) premiums (a lower death benefit may not be needed as much now for estate tax planning and the lower death benefit could provide stability to the policy).
Another consideration for clients is that the Act may be amended or revoked. The Act likely would be amended or repealed if President Trump is not reelected and the Democratic Party gains control of the House and the Senate. Some clients may want to consider taking advantage of the increased exemption amounts by making current gifts to family members or trusts or implementing a gifting strategy for so long as the increased exemption amounts remain available.
Every estate plan and estate planning client is unique, so the Act will impact each client differently. Some clients, for example, will want to retain income producing assets while gifting non-income producing assets. Some clients may want to unwind trusts while other clients may want to continue trusts for tax planning or asset protection reasons.