TAX REFORM: Federal Gift, Estate and Generation-Skipping Transfer Taxes - No Permanent Repeal, but Double Exemptions Create Significant Planning Opportunities

by Dechert LLP
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On December 22, 2017, President Trump signed into law new tax legislation (the “2017 Tax Bill”). The 2017 Tax Bill makes sweeping changes to the U.S. tax code, including a reduction in corporate tax rates, significant changes to the taxation of individuals, a repeal of the Affordable Care Act’s “individual mandate,” and a number of other changes.

This update focuses on how this law affects individuals from an estate planning and transfer tax perspective, including charitable gift planning, income taxation of trusts and estates and asset transfers generally.

Estate, Gift and GST Tax Exemption Doubles to Approximately US$11.2 million per Individual

While some previous versions of the tax bill included a full repeal of the estate tax, the signed 2017 Tax Bill maintains the estate and gift tax at a 40% rate but doubles the exemption from gift and estate tax to approximately US$11.2 million per individual (US$22.4 million per married couple), beginning on January 1, 2018. This increase also applies to the exemption from generation-skipping transfer (“GST”) tax, which also increases to US$11.2 million per individual (US$22.4 million per married couple). The other rules applicable to gift and estate taxation, such as heirs receiving fair market value basis for assets received from an estate, remain unchanged.

This US$11.2 million exemption will continue to be adjusted for inflation each year. However, the 2017 Tax Bill changes how the inflation adjustment will be calculated, now using “chained CPI” as the measure of inflation, which will generally result in a smaller annual inflation adjustment. 

Along with most other changes to the individual tax regime, this increased exemption is scheduled to “sunset” after 2025, although the change to using chained CPI is not scheduled to expire. This increased exemption creates significant planning opportunities for individuals, particularly those with estates in excess of the increased limits. 

Clients Should Consider Using This Increased Exemption Starting in 2018

Clients should consider making gifts (either outright or in trust) in order to utilize this increased exemption, particularly since this increased exemption is scheduled to expire at the end of 2025. In addition, other estate planning techniques, such as GRATs and sales to grantor trusts, can still be used under the new 2017 Tax Law. 

Clients Should Review Current Estate Plans in Light of the Increased Exemption

One planning item to consider is that many clients have wills and other estate planning documents that use formulas based on the exemption amounts available at the client’s death. For example, an individual’s will may leave an amount equal to her available exemption from the estate tax to her children (either outright or in trust) and the balance over the exemption to her spouse. Without changing her documents, the change in the law increases the amount passing to the children and decreases the amount passing to her spouse by more than US$5 million. Accordingly, clients should review their current estate planning documents to ensure that their plans and these formulas still accurately reflect their wishes in light of the dramatically increased exemption amounts.

In addition, clients who live in New York State and whose estate planning documents fund trusts with the entire federal exemption amount may owe significant New York estate tax on the death of the first spouse and, therefore, may wish to review the structure of their estate plans. Clients living in other states that have state estate or inheritance taxes may also have similar tax considerations.

529 Plans May be Used for Educational Expenses for K-12 

The Tax Bill also expands the use of 529 plans so that they may be used for K-12 education. 529 plan funds (up to US$10,000 per year per beneficiary) can now also be used for tuition expenses for any elementary or secondary school, including public, private, or religious schools. Previous law only allowed 529 plan funds to be used for college and other post-secondary programs and expenses. A previous provision also allowed 529 plan funds to be used for homeschooling expenses, but that provision was removed from the final 2017 Tax Bill.

Limit on Deductions for Charitable Cash Contributions Increases to 60% of AGI

In addition, although the 2017 Tax Bill limits a number of income tax deductions, it does increase the deductibility limitation for cash contributions to public charities from 50% to 60% of adjusted gross income. This increase is scheduled to expire after 2025. Other charitable contributions (such as contributions of appreciated property and contributions to private foundations) are still subject to the 30% (and in some cases 20%) of adjusted gross income limitations, and the ability to carryover unused charitable contribution deductions for five years remains unchanged. 

Many Changes to Individual Taxation Also Affect Trusts and Estates, Including the New 20% Deduction for Certain “Pass-through” Income

Many of the changes to the taxation of individuals (e.g., reduction in tax rates, limitation on state and local income tax deductions, etc.) will also apply to trusts and estates. 

However, one change of particular importance for trusts and estates is the deduction for income received from pass-through entities. 

Under the 2017 Tax Bill, trusts and estates are entitled to take the 20% deduction for pass-through income also applicable to individuals, which creates an effective tax rate of 29.6% for most pass-through income earned by a trust. While beyond the scope of this discussion, certain restrictions apply to the availability of this deduction. It is important for trustees of trusts that own interests in pass-through entities to understand the effect of these rates on fiduciary income tax obligations. 

Conclusion

Although the ultimate scope and effects of the 2017 Tax Bill will continue to unfold, the most significant change from a transfer tax and estate planning perspective is the doubling of the estate, gift and generation-skipping transfer tax exemptions to approximately US$11.2 million beginning on January 1, 2018.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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