United States: How Will The New Tax Legislation Affect Your Estate Plan?

Last Updated: January 3 2018
Article by Thomas Vance LLM, JD

The new tax legislation makes many changes to individual and corporate tax rates, eliminates a host of deductions and credits, enhances other breaks and makes numerous additional changes.

One thing the new law doesn't do is repeal the federal gift and estate tax. It does, however, temporarily double the combined gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption, creating new estate planning challenges and opportunities.

Impact on Your Estate Plan

Effective after December 31, 2017, and before January 1, 2026, the inflation-adjusted gift and estate tax exemption and the GST tax exemption amounts for 2018 are expected to be $11.2 million (single) and $22.4 million (for married couples with proper planning). The exemptions will revert to their 2017 levels (adjusted for inflation) beginning January 1, 2026. The marginal tax rate for all three taxes remains at 40%.

According to some estimates, the increased exemption amounts will reduce the number of U.S. estates subject to estate tax from approximately 5,000 to around 2,000. While the possibility of estate tax liability may be remote for most families, all families would benefit from some estate planning.

There are many non-tax issues to consider when planning your estate, including asset protection, guardianship of minor children, family business succession and planning for loved ones with special needs. Also, states may not follow the federal changes. If you live in a state with significant estate taxes, many traditional tax-reduction strategies will continue to be relevant.

It is also important to keep in mind that the exemptions are scheduled to revert to their previous levels in 2026 and future laws could reduce these amounts even further. However, the new law does provide for regulations that will preserve its benefits, even if the additional exemption amounts are reduced or expire. While there are no guarantees with respect to future legislation, the new law presents significant planning opportunities that should not be missed.

Planning Opportunities

Record-high exemption amounts, even if temporary, create a rare opportunity to take advantage of strategies for "locking in" those exemptions and permanently avoiding future transfer taxes. These include:

Lifetime Gifts

By using some or all of the increased exemption amount to make additional tax-free lifetime gifts, you can shield that wealth — together with any future appreciation in value — from taxation in your estate, even if smaller exemptions have been reinstated when you die.

Keep in mind, though, that lifetime gifts, unlike assets transferred at death, are not entitled to a stepped-up basis. This can increase income taxes on any gain realized by the recipients should they sell a gifted asset. So, when considering lifetime gifts, it is important to weigh the potential estate tax savings against the potential income tax costs.

Dynasty Trusts

Now may be an ideal time to establish a dynasty trust. These irrevocable trusts allow substantial amounts of wealth to grow and compound free of federal gift, estate and GST taxes, providing tax-free benefits for your grandchildren and future generations. The longevity of a dynasty trust varies from state to state, but it is becoming more common for states to allow these trusts to last for hundreds of years or even in perpetuity.

Avoiding the GST tax is critical. With an additional 40% tax on transfers to grandchildren or others that skip a generation, the GST tax can quickly consume substantial amounts of wealth. The key to avoiding the tax is to leverage your GST tax exemption.

By properly allocating your GST tax exemption to your trust contributions, you can ensure that any future distributions of trust assets to your grandchildren or subsequent generations will avoid GST taxes. Similar to the benefit of lifetime gifts, once a contribution is exempt from GST, the appreciation on those assets remains exempt from the GST.

Other Considerations

The new law makes several other changes that may have an impact on estate planning strategies. For example:

529 Plans

The new law permanently expands the benefits of 529 college savings plans. These plans, which permit tax-free withdrawals for qualified educational expenses, also offer some unique estate planning benefits.

Contributions to 529 plans are removed from your estate even though you retain the right to change beneficiaries or get your money back. And you can bunch five years' worth of annual gift tax exclusions into one year. So, for example, in 2018 when the annual exclusion is $15,000, you can contribute $75,000 to a plan ($150,000 for married couples) without triggering gift or GST taxes or using any of your exemptions.

In addition, beginning in 2018, tax-free distributions from 529 plans can be used for elementary and secondary school expenses, not just higher-education expenses, making them even more valuable.

"Kiddie" Tax

The new law also makes an important change to the "kiddie" tax. One popular estate planning technique is to transfer investments or other income-producing assets to your children to take advantage of their lower tax brackets.

Before the new law, most of the benefits of income-shifting were eliminated because the kiddie tax imposed the parents' marginal tax rate on all but a small portion of a child's unearned income. The kiddie tax generally applies to children age 18 or younger, as well as to full-time students age 19 to 23 (with some exceptions).

Under the new law, the kiddie tax is harsher. A child's unearned income is taxed under the tax brackets for trusts and estates, which reach the highest brackets at much lower income amounts (for example, in 2018 the 37% bracket is applied to income over $12,500). For a married couple filing jointly, the highest rate doesn't kick in until their 2018 taxable income tops $600,000. In other words, in many cases, the new law will tax children's unearned income at higher rates than their parents' income.

Charitable Planning

The new law raises the adjusted gross income limitation for deductions of cash donations to public charities from 50% to 60% from 2018 through 2025. However, because fewer people will be subject to federal gift and estate taxes, and because of increases in the standard deduction and decreases in the income tax rates, charitable strategies designed to reduce those taxes will be less valuable.

Review Your Plan

These and other changes may have a significant impact on your estate planning strategies. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Thomas Vance LLM, JD
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