The Tax Cuts and Jobs Act (TCJA) has doubled the amount that can be exempted from federal estate tax to $11.18 million per individual, effective January 1, 2018. This provides taxpayers with an excellent opportunity to accomplish significant asset protection and business succession planning until the provision sunsets at the end of 2025.
Since the TCJA limits the deductibility of state and local income, real estate, and sales tax (SALT) to $10,000 in the aggregate, some taxpayers may consider creating trusts to shift income beyond the reach of state tax authorities. The income would be subject to the highest tax rate at the federal level for all income over $12,500, but it could avoid state income taxes entirely. Taxpayers may also wish to take additional SALT deductions at the trust level. By breaking up ownership of an asset in a high-tax jurisdiction through trusts, taxpayers may be able to shield more income from federal taxation.
Asset protection and business succession goals.
With federal estate tax exemption levels increased to $11.18 million (per Revenue Procedure 2018-18), taxpayers may wish to consider the following points:
- Enactment of the TCJA was done on party lines, and there is a possibility that a flip in control of Congress could result in a rollback of the increased exemption.
- Planning can be accomplished by transferring assets without necessarily losing access to those assets or the income.
- Even with the increased exemption, insurance planning is still important. It can not only create dynastic wealth, it can also provide for liquidity for heirs to run family businesses.
The TCJA virtually doubled the standard deduction and eliminated most itemized deductions. Thus, to maximize the tax benefit of charitable contributions, taxpayers may want to consider—
- bunching charitable contributions by using donor-advised funds,
- contributing IRA required minimum distributions (up to $100,000 per year for taxpayers over 70½ years) to charity, or
- establishing foundations or charitable trusts to accomplish philanthropic objectives.
Income tax planning.
The increased estate and gift tax exemptions will require planners to consider the income tax effects of wealth transfer strategies.
- Terminating trusts and closing out estates need to be reviewed carefully. To the extent that there is a net operating loss (NOL) at the trust/estate level, this will be passed through to an individual beneficiary as an “excess deduction” that is no longer permitted to be deducted by the individual. Fiduciaries will need to consider the potential impact of NOLs before making final distributions.
- The increased exemptions may offer an opportunity for wealthy taxpayers to transfer highly appreciated assets to a close family member (or trust for such person’s benefit) with a modest estate. Using careful drafting techniques, such a transfer could cause the asset to be included in such a family member’s estate, thereby permitting a step-up in basis without resulting in estate taxation.
- Substituting highly appreciated assets in grantor trusts in exchange for high-basis assets (such as cash) is still a viable planning strategy. The purpose would be to achieve a step-up in basis while still shielding substantial wealth from estate taxation.
Even with the increased exemption, insurance planning is still important.
Beware the Clawback
As the TCJA wound its way through Congress, many questioned whether the benefit of avoiding gift tax by using the increased lifetime exemption on gifts made between 2018 and 2025 would be recaptured if death or other gifts were made thereafter. The TCJA attempts to address these clawback concerns by instructing the Treasury Secretary to “prescribe regulations” to prevent any such clawback. While most commentators concur that it is unlikely that there will be any clawback of gifts made during this time, taxpayers should be cautioned of this risk. The best course is to have an agreement between the donor and donee in place when the gift is made and accepted.