The tax bill that was recently signed into law makes significant changes to federal estate, gift and generation skipping transfer (GST) taxes. These changes create additional opportunities for wealthy clients to reduce or eliminate federal estate, gift and GST taxes as they transition wealth to future generations.
Exemption Amounts Double – A benefit for many but an unintended complication for others. The federal estate, gift and GST tax exemptions were increased from $5 million to $10 million (adjusted annually for inflation) per individual. For 2018 the federal estate, gift, and GST tax exemption is $11.18 million per individual. The increased exemptions, however, are not permanent – they are scheduled to revert back to $5 million (adjusted annually for inflation) per individual on January 1, 2026. As the law is currently written, taxpayers have only a few years to take advantage of the increased exemption amounts. Clients may wish to consider lifetime gifting during this brief window of opportunity before the increased exemptions are lost.
While the increased exemption amounts are very beneficial to taxpayers in general, the changes may alter some estate plans in ways that were unanticipated. Many estate plans were drafted to reference the federal estate tax exemption amount in the year of death to ensure that the federal estate tax exemption was fully utilized and not wasted. Estate plans that reference the exemption amount to define transfers to spouses, children, grandchildren or charities may no longer accomplish a taxpayer’s goals. For example, it is common to see transfers to children based upon the federal estate tax exempt amount in the year of death, with any remaining amounts passing to a surviving spouse. For a taxpayer with a $10 million net worth, this planning made sense when the federal estate tax exemption was $5 million with annual inflation adjustments. The taxpayer would fully utilize the exemption, transfer considerable assets to his/her spouse and pay no federal estate tax. Under the new law, the taxpayer’s goals may not be realized because the language of the estate plan will lead to very different results – the children would receive all $10 million of the estate and no federal estate tax would be paid, but nothing would be transferred to the surviving spouse.
Basis Step-up and Federal Estate, Gift and GST Tax Rates Remain Unchanged
The new tax law did not change the federal estate, gift and GST tax rates – they remain at 40 percent.
Furthermore, the new law did not repeal the basis step-up of assets at death. The tax basis of assets received from a decedent is equal to the fair market value of the asset on the date of the decedent’s death. Assets received via gift during the lifetime of the donor do not receive a basis step-up, rather the tax basis of gifted asset is equal to the donor’s tax basis in the asset. Prior to completing any large lifetime gifts, clients should consider the income tax consequences of gifting assets versus holding assets until death.
Other Tax Law Changes
In addition to the changes to estate, gift and GST taxes, the new tax law includes numerous provisions that will significantly affect wealthy individuals, including: a reduction in the corporate income tax rate to 21 percent, creation of a new 20 percent deduction for some pass-through income and the elimination or limitations of various itemized deductions.
Minnesota’s estate tax exemption increased to $2.4 million for 2018. Like those in many other states, it is anticipated that Minnesota lawmakers will spend much of the 2018 legislative session addressing state tax issues in response to the new federal tax law.
In light of these significant changes, we advise clients to speak with their attorney to discuss planning opportunities and to review their estate planning documents.