Tax Cuts and Jobs Act: What you need to know about the Estate, Gift & Trust Provisions

Posted on 01.25.18

Tax Cuts and Jobs Act: What you need to know about the Estate, Gift & Trust Provisions

By Lynne Howard, Tax Senior Manager | Family, Executive & Entrepreneur Advisory Services Team

The 2017 Tax Cuts and Jobs Act signed by the President on December 22, 2017 contains several key estate planning provisions. We have spotlighted several of the most applicable provisions:

  • Exclusion Doubled
    The new law temporarily doubles the estate and gift tax applicable exclusion amount, from $5 million to $10 million (2011 dollars), for gifts made after and estates of decedents dying after December 31, 2017, and before January 1, 2026. By increasing the applicable exclusion amount, the new law automatically increases the GST exemption.  The 40% estate tax rate still applies as well as basis “step-up” and portability.  Taxpayers still need to file gift tax returns to track gift and GST exemption amounts used, even if allocations are automatic.
    • Planning opportunity
      More detail follows, but it is very important to review your current estate documents to make certain that the increase in exemption does not create any unintended consequences.  Use this window to consider additional gifts in order to remove appreciation on those assets from your estate.  The opportunity also exists to make late GST allocations to trusts with an inclusion ratio greater than zero. Keep in mind that the law is set to sunset in 2025 with no guarantee as to the exclusion amount in 2026.
  • Change in Indexing

    The new law retains the inflation adjustments to the applicable exclusion amount and GST exemption.  Starting in taxable years after 2017, the slightly less generous Chained Consumer Price Index (chained CPI) will be used.  The 2018 exclusion will be $11.18 million, just slightly less than the $11.2 million using the traditional CPI measure.  

  • Annual Exclusion

    The 2018 gift tax annual exclusion amount will still increase to $15,000. This was unaffected by using the chained CPI vs. the traditional CPI.

  • State Income Taxes

    It is unclear whether state and local taxes will be deductible within a trust, will be subject to the $10,000 limit imposed on individuals or be non-deductible all together. Either way trustees should focus on state tax reductionto minimize any potential tax impact.

    • Planning opportunity
      Consider a shift to investments that are exempt from state income tax or changing trust situs to a state with low or no income tax.  As with any financial decision, tax is only one aspect; full consideration should be given to all economic factors.
  • Cash Gifts to Public Charities

    The new law temporarily increases the income based percentage limit for certain charitable contributions by an individual taxpayer of cash to public charities and certain other organizations from 50% to 60%. This change applies to contributions made in any taxable year beginning after December 31, 2017, and before January 1, 2026.  Trusts and estates (except ESBTs) charitable deductions are still deductible to the extent paid out of current year income.  The 60% limitation does not apply and there are no carryovers.

    • Planning opportunity
      Consider accelerating charitable giving during lifetime to reduce estate tax and possibly receive an income tax deduction.  Larger gifts now not only decrease your overall estate, but also eliminate the appreciation on the assets donated.
  • Charitable Gifts by ESBTs

    The new law modifies the rules regarding charitable contributions by an Electing Small Business Trust (ESBT), subjecting these trusts to the rules applicable to individuals, rather than those applicable to trusts. The percentage limitations and carryforward provisions applicable to individuals apply to charitable contributions made by the portion of an ESBT holding S corporation stock.

  • Qualifying Beneficiaries of an ESBT

    The new law permits a nonresident alien individual to be a potential current beneficiary of an ESBT, beginning January 1, 2018.

  • The Kiddie Tax

    The new law temporarily taxes the net unearned income of a “child” at the ordinary income and capital gains rates applied generally to trusts and estates (see table below), with respect to taxable years beginning after December 31, 2017 through 2025.  Children subject to kiddie tax has not changed. Those impacted generally include:  (1) under 18 at the end of the year, (2) over 18 but less than 19 at the end of the year and the child’s income didn’t exceed 50% of the child’s support or (3) between ages 19 and 24 at the end of the year, but a full time student and the child’s income didn’t exceed 50% of the child’s support. 

    • Note:  This change will increase the “kiddie” tax paid by “children” as the higher trust and estate income tax brackets are reached at lower income levels.  The 20% flat tax on Qualified Dividends and Long Term Capital Gains is also reached at a much lower income tax level.
  • Life Insurance

    The new law imposes new reporting requirements for the purchaser who buys an existing life insurance contract in a “reportable policy sale” and the insurer who pays death benefits on such policies.  Also, the various exceptions to the transfer for value rules do not apply in the case of a transfer of a life insurance contract, or any interest in a life insurance contract, in a reportable policy sale. The new law also provides that, in determining the basis of a life insurance or annuity contract transferred during the owner's lifetime, no adjustment is made for mortality, expense, or other reasonable charges incurred under the contract, reversing the position taken by the IRS in Rev Rul 2009-13. This change applies to transactions entered into after August 25, 2009.

  • Miscellaneous Itemized Deductions

    The new law temporarily eliminates individual tax deduction for miscellaneous itemized deductions subject to the 2% floor. This applies to taxable years beginning after December 31, 2017, and before January 1, 2026.  Estates and trusts are not subject to the 2% rule for those costs incurred in connection with the administration of an estate or trust that would not have been incurred if the trust’s property were not held in trust.

    • Planning opportunity
      It is recommended to review the expenses incurred by the trust in asset management and trust administration for proper classification in order to maximize deduction.
  • Pass-Through Businesses Owned by an Estate or Trust

    The new law provides that, for taxable years beginning after December 31, 2017 and before January 1, 2026, an individual taxpayer “generally” (there are certain limitations) may deduct 20% of “qualified business income” from a partnership, S corporation, or sole proprietorship. The new law extends this rule to interest owned by trusts and estates.

  • Partnership “Substantial Built in Loss”

    Generally for transfers at death, if an IRC Section 754 election is in effect, or if the partnership has a “substantial built-in loss” immediately after the transfer, adjustments are made with respect to the transferee partner. Under pre-Act law, a substantial built-in loss exists if the partnership's adjusted basis in its property exceeds by more than $250,000 the fair market value of the partnership property. Under the new law, for transfers of partnership interests after December 31, 2017, the definition of a substantial built-in loss is modified.  In addition to the present law definition, a substantial built-in loss also exists if the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all partnership's assets in a fully taxable transaction for cash equal to the assets' fair market value, immediately after the transfer of the partnership interest.

  • 2018 Tax Brackets for Trusts & Estates – under new law:

Taxable income over

But not over

Tax rate

$0

$2,550

10%

$2,550

$9,150

24%

$9,150

$12,500

35%

$12,500

 

37%

Note:  The 20% flat tax on Qualified Dividends and Long Term Capital Gain will be applicable for income greater than $12,500. 

Estate Planning Considerations Under the 2017 Tax Cuts and Jobs Act

The increased exclusion amount may have a significant impact on your current estate plan and how funds flow to beneficiaries. They may allow your non tax planning goals to receive additional emphasis without tax penalty.  Regardless of the size of your estate, at a minimum you should review your will and trusts, specifically formula clauses, to make sure that the plan still reflects your intended result.  Even existing irrevocable arrangements should be reviewed to see if there are solutions that make them more flexible and basis friendly.  In addition, many states do not conform to the federal exclusion amounts, so state estate tax implications should also be reviewed. 

While the increased basic exclusion amount under the 2017 Tax Cuts and Jobs Act is scheduled to sunset on December 31, 2025, Congress could change the Act prior to its sunset. This “window” should be viewed as an increase in the gift tax applicable exclusion amount, as much or even more than the estate tax applicable exclusion amount, because there is no certainty that these increases will be preserved. Consider making any lifetime gifts and allocations of GST exemption sooner rather than later.

Estate planning techniques to consider during this “window” of opportunity

  • For very wealthy taxpayers who may have already used all of their prior exclusion, the best plan may be to make an additional $5 million ($10 million for a married couple) irrevocable gift to one or more generation-skipping trusts in 2018. This will shift future appreciation onto gifted assets and lock-in the use of the added applicable exclusion amount and GST exemption (assuming no claw back).
  • For individuals reluctant to part irrevocably with such large sums, and who may want to preserve their continued benefit from the transferred funds, either as a primary or secondary beneficiary, there are two possible solutions. The pros and cons of these should be discussed with your attorney.
    • Create a self-settled spendthrift trust in which the grantor remains a discretionary beneficiary.
    • Create a trust for the benefit of your spouse.  See discussion regarding SLAT later.
  • The increased GST exemption may be an opportunity to address existing irrevocable trusts with an inclusion ratio greater than zero. Where assets may ultimately pass to skip persons (either by design or due to changed facts), consider making a late allocation of GST exemption to cause such trusts to have inclusion ratios of zero.
  • Consider making transfers that take advantage of valuation discounts to maximize the value transferred.
  • Consider a sale to Intentionally Defective Grantor Trusts (IDGT).

    • This freeze technique usually requires a seed gift of 10% followed by a sale of nine times that amount.  Now a married couple’s seed gift could be $22 million and they could sell almost $200 million.
  • Consider the use of four to eight year Grantor Retained Annuity Trusts (GRATs) for those with wealth between the old exemption and the new exemption amount. This would force inclusion and obtain a “step-up” sunset in case of death. GRATs are a freeze technique intended to remove growth on GRAT assets, gift tax free, from the estate.

  • Consider the use of a Springing Spousal Lifetime Access Trust (i.e. SLAT with contingent General Power of Appointment (GPOA) provision).  The SLAT strategy emerged in late 2012 when the estate tax exemption was $5.12 million and was scheduled to drop to $1 million in 2013. The SLAT is similar to a bypass trust that provides income and/or principal for the needs of the surviving spouse. The difference is that a SLAT if funded via gift while the donor is still alive.  The contingent GPOA would pull the trust back into the donor’s estate, to the extent it would not cause estate taxes, allowing the assets a step up in basis (unlike your typical bypass trust).
  • Consider the selection of fiscal year end for an IRC Section 645 election estate/trust.  This can be especially important for the current year because the end of the reporting period determines applicable law for pass-through income.  The estate may choose a fiscal year end up to the month before the month of death. The IRC Section 645 election allows a qualified revocable trust to be taxed as if it’s part of the estate, thereby avoiding that the trust have a December 31, 2017 year end. 

Conclusion

Keep in mind, this is a unique opportunity to transfer wealth to others. Regardless of the size of your estate, at a minimum, you should review your will and trusts, specifically formula clauses, to make sure that the plan still reflects your intended result.  This “window” is set to sunset after 2025, but may be changed at any point.  If you intend to make gifts and/or rework your estate, please do so sooner rather than later.

If you have any questions about the new law or need help in determining how the new law will affect your existing estate plan, Keiter is ready to help. Keiter Directory | Email | 804.747.0000

Additional Tax Planning Resources:

Sources:

  • Howard Zaritsky’s Estate Planning Update 1/1/18
  • AICPA Tax Reform Overview
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.

Posted by: Lynne Howard, CPA/PFS

Lynne has extensive experience in the estate, trust, and gift area, but also applies her experience to provide tax planning opportunities and insights to operating entities, investment partnerships, real estate entities, and high wealth individuals and families. Currently, she works closely with individuals and family offices to address their various tax compliance, consulting, and estate planning needs. She also serves as an advisor to her clients on matters indirectly related to taxes and estate/gift planning. Read more of Lynne's insights on our blog.