Many articles have been written about how the changes made by the Tax Cuts and Jobs Act of 2017 (TCJA) will affect estate planning. These changes have consequences extending beyond the mere temporary increase in the exemption amount. While mastering the technical aspects of the TCJA is challenging, communicating to individuals the need to update existing planning, take advantage of the new tax environment, and undertake new planning may be even more difficult. How can CPAs educate clients about the importance of continued planning? While this subject is nontechnical, it is vital to address, or most individuals simply won’t plan. This column contains the authors’ typical responses to some of the most frequent arguments against updating an estate plan in the wake of the TCJA.
My Estate Is Too Small for Tax Planning to Matter
This will be true for many individuals, but estate taxes never should have been the only, or even the most important, factor in anyone’s planning. Advisors should stress that, regardless of the size of the estate, everyone needs planning. The response to this objection should take several approaches, depending on the individual’s circumstances.
CPAs understand that estate planning should address an array of nontax issues. Aging individuals should address later life planning to protect themselves from elder financial abuse and other potential problems. This might include consolidating assets with a single wealth advisor, funding a revocable trust naming a trust protector for a check and balance on the trustee, and much more. Asset protection is a critical step for many individuals, not just the rich. Few people to take sufficient steps to protect their assets. Even fewer follow up regularly on the operation of the asset protection structures that they do create. Advisors need to reinforce the importance of nontax planning in a manner relevant to that individual.
Adam created an LLC to hold investment assets, and noncontrolling interests in that LLC were gifted to various family trusts. This plan removed assets from Adam’s estate when, at a lower exemption level, he was concerned about estate tax. More significantly, he remains concerned about malpractice claims, and this structure of irrevocable trusts and an LLC was viewed as providing protection. It could, but if Adam does not adhere to the formalities of proper administration of the structure, the planning will be undermined. What if he swaps assets with one of the grantor trusts without adhering to the specific requirements contained in the trust agreement, did not issue Crummey notices when gifts were made to an irrevocable trust that owns life insurance, or borrowed money from the LLC without signing a note? As these types of operational issues proliferate, the risk of a claimant or the IRS piercing the structure increases. Planning to properly maintain trusts and entities at every wealth level is vital.
Regardless of wealth level, income tax planning after the TCJA, such as that which might be achieved using nongrantor trusts, could be valuable. Many moderate- and lower-wealth taxpayers dismiss the need for planning because their estates are too small.
Bonnie donates $10,000 per year to charity. Her donations post-TCJA, along with her state and local tax deductions and deductible medical expenses, do not exceed the standard deduction of $24,000. She will not receive any tax benefit from donation. Planning might capture the lost deduction; she could transfer $200,000 to a nongrantor trust that names family and charities as beneficiaries. If that trust earns 5% a year (i.e., $10,000) and that is donated to charity, the full amount could be deductible.
The recently doubled exemption amounts are only temporary: the TCJA provides that the $10 million (11.18 million with adjustment for inflation) estate tax exemption will revert to $5 million in 2026. For those individuals with sufficient wealth, using these temporary exemptions before they are effectively halved is critical planning. Many who view the exemptions as so high that estate tax planning has become irrelevant should be counseled to evaluate their circumstances.
Charles has a $4 million estate. If the exemption is indeed cut in half in 2026, the growth in his estate from now until then might make his estate taxable at that. Shifting even a modest portion of Charles’s wealth into an irrevocable trust now under the TCJA’s higher exemptions amounts could avoid that risk.
I Already Updated My Planning a Few Years Ago
One of the most common ways individuals deflect a conversation about the need to update their estate planning is to suggest that they updated their plan and documents only a few years ago. If a new medicine were developed, no one would ignore it because their doctor had prescribed a different medication a few years before. Taxpayers certainly can be annoyed by changes in the tax law, but they ignore those changes at their own peril.
The most common excuse for not addressing planning is “nothing has changed,” but with the TCJA, much has changed. If individuals have wills (or revocable trusts) that use formula clauses, those formulas could be disastrous under the new law if not updated.
Debra’s will bequeaths the maximum generation-skipping transfer tax (GST) amount outright to her grandchildren, with the remainder outright to her children in equal share. At the time the will was drafted, the GST exemption was $1 million, and Debra’s estate was $5 million. That would have transferred $100,000 to each grandchild and $2 million to each of her two children; her estate, however, has grown to $10 million and the exemption to $11.18 million. Thus, the entirety of her estate will pass to her grandchildren, and her children will be disinherited, which was not her intent. Furthermore, when she thought the amount per grandchild was limited, she was unconcerned about an outright bequest; now that the amount has grown, the lack of trusts to protect such substantial amounts is worrisome.
Whether with respect to this issue or one of a myriad of others, all old documents should be reconsidered. Allocation of assets, as between a credit shelter trust and a qualified terminable interest property (QTIP) trust, is often based on formulas. Will those formulas work under the current law with an exemption that is dramatically greater than when those documents were created? Will the formula work when the exemption is reduced by half in 2026? Reviewing and testing estate planning documents, as well as considering the ownership (title) of assets, are critical to determining whether a plan meets a client’s current and future objectives.
The Law Changes All the Time; Why Bother?
There have indeed been many years over the last decade when clients have received newsletters, emails, or even calls from their advisors encouraging them to update documents and planning for changes in the law. For such individuals, the frustration is understandable, but the solution is obvious as well. Modern trust and estate planning can utilize several provisions to incorporate flexibility into the planning and documents, far more so than what conventional planning afforded only a few years ago. These tools are discussed below.
Revocable trusts can be used instead of wills to provide more flexibility, such as to move a trust formed on death to a better jurisdiction (i.e., friendlier legal and tax environment). Trusts might also include a trust protector empowered to make certain changes to the trust agreement, move the situs and governing law of the trust, and so forth.
Decanting (the process of merging an old trust into a newer trust with better or more modern administrative provisions) has become more common in recent years. But advisors should not depend upon state law alone to facilitate a decanting. New trusts can include these provisions as well. Encourage the client’s attorney to use robust trusts that include this and other modern trust provisions.
In the current planning environment, non-grantor trusts (which pay their own tax, and might provide some IRC section 199A, state and local tax, charity, and other benefits) are popular. If the individual tax changes enacted as part of the TCJA sunset after 2025, as the law provides, it may be more advantageous to convert nongrantor trusts back to a grantor trust. The powers that create grantor trust status might include provisions to renounce those powers so that conversion to a nongrantor trust is also feasible. A person could be named in the trust instrument—perhaps expressly designated not to act in a fiduciary capacity—who can exercise powers to turn on or off grantor trust status.
Powers of appointment (the right to designate to whom trust assets shall pass) are more frequently being included in instruments. Historically, these had been used primarily to avoid an unintentional GST tax; now, however, they are used to provide important flexibility to effectively rewrite trusts, given the tendency towards using long-term or even perpetual trusts. Powers can also be modified from limited powers into general powers of appointment, which can cause a step-up in basis on death.
There are many ways that a modern trust can be made more flexible to deal with continued uncertainty. The sooner individuals embrace modern trust and estate drafting, the sooner they can infuse their documents with this flexibility.
Estate Planning Has Nothing to Do with My Investments or Financial Advisor
Financial planning, investment location decisions, and insurance planning have all been affected by the TCJA. No estate plan can be addressed optimally without addressing these matters as well.
Some individuals might cancel their life insurance policies, believing that those policies are no longer necessary to pay an estate tax they no longer expect to owe. Even if this was the primary reason for the purchase initially, it should not be the only factor to consider when evaluating a policy now. Might the policy be useful to pay an estate tax when the exemption is halved in 2026? What if the value of the estate compounds at a rate that subjects it to estate tax? Does the insurance provide a ballast to offset the risk of concentration of most of the estate in a closely held business?
Investment allocation and location decisions should be tailored to the individual’s circumstances and estate plan. In very simplistic terms, a financial advisor might concentrate tax-efficient assets, such as growth stocks, in personal accounts and tax-inefficient assets, such as bonds, in qualified plan accounts (where they will not generate current income tax). Post-TCJA, many clients will benefit from creating non-grantor trusts (like the one used for charitable planning illustrated above). Some portion of the income from these trusts may pay charitable donations and provide a dollar-for-dollar deduction, which the client might not realize individually because of the higher standard deduction. Some nongrantor trusts will be formed and administrated outside of the taxpayer’s high-tax home state, thus presenting trusts with a new and unique tax bucket for asset location decisions. Tailoring the investment location decisions to account for the tax profile of the trusts is another important nuance to better planning.
As individuals with moderate wealth seek to capitalize on the current high temporary gift, estate, and GST exemption amounts, they may transfer substantial portions of their wealth to irrevocable trusts. Having an appropriate insurance plan (e.g., life, long-term care) to backstop these transfers could be a new, important use of insurance planning for some clients.
Roth IRA conversions can provide valuable income tax benefits for many individuals. Since the TCJA has doubled the standard deduction, however, using regular IRA funds to make charitable contributions may be an ideal way to secure charitable contribution deductions for some individuals. This calculation adds a new wrinkle to the Roth conversion analysis.
Awareness Is the First Step
The TCJA has made dramatic changes to income and estate tax planning, as well as insurance, investment, and other planning. The prerequisite to individuals realizing any of these benefits, however, is CPAs educating them as to why these benefits are relevant.