On Dec. 22, President Donald Trump signed the Tax Cuts and Jobs Act (the Act), marking the most significant changes in federal tax law in 32 years. The Act makes sweeping changes for both individuals and corporations, and doubles the amount of the federal estate and gift tax basic exclusion amount (the exclusion). The focus of this article is to explore the impact of the increase on the exclusion on estate administration and planning going forward.
Estate, Gift and Generation-Skipping Tax Changes in the Act
The exclusion amount for estate, gift and generation-skipping tax purposes was increased from $5 million to $10 million, as indexed for cost-of-living adjustment starting from 2010. Those cost-of-living adjustments had resulted in a 2017 exclusion of $5.49 million, which was scheduled to increase to $5.6 million for 2018. The result is that for 2018, the exclusion will be $11.2 million per person ($22.4 million for married couples).
The increase in the exclusion only applies to estates of decedents dying after Dec. 31, 2017, and before Jan. 1, 2026, and to gifts made during that period. The provision then sunsets in 2026, going back to $5 million per person, indexed for cost of living.
Impact on Estate Administration
Since 1997, the exclusion has increased substantially, while the estate tax rate has fallen. The effect of these changes has been to dramatically reduce the number of estate tax returns filed annually, as well as the amount of dollars raised by the tax. In the years since the exclusion was increased to $5 million, approximately 60% of the returns filed showed estate values under $10 million, so we can expect to see the number of taxable returns to drop at least 60%. However, these returns only accounted for about 14% of estate tax paid during this period. So while the number of returns that need to be filed will decrease substantially, the amount of revenue generated by the estate tax will not.
The decrease in the number of returns that will actually be filed may not be as large as these statistics would indicate. This is because the exclusion is portable between spouses. To the extent the first spouse to die does not utilize his or her exclusion, the surviving spouse can use it. But in order to claim the first spouse’s unused exclusion, an election must be made on a timely filed estate tax return. So a return will often be filed for the first spouse even when the size of the estate is not over the filing requirement.
This is especially true in light of the sunset provision in the Act. If the first spouse dies before Jan. 1, 2026, his or her exclusion will be based on the $10 million basic exclusion and can be preserved for the surviving spouse, even if the second death is after that date, when the $5 million basic exclusion returns. The surviving spouse will be entitled to the first spouse’s larger exclusion, plus his or her own smaller exclusion.
Another complication caused by the sunset provision relates to adjusted taxable gifts. Suppose a taxpayer makes a gift in 2018 for the full amount of the exclusion, $11.2 million, and dies in 2026 after the sunset, when the exclusion is back to $5 million, as adjusted for cost of living. The estate tax is calculated by adding the value of the decedent’s taxable estate and the value of lifetime adjusted taxable gifts to determine the adjusted taxable estate.
So the taxpayer could have an estate tax due even though the gift was not taxable when made, and there were no assets left in the estate upon death. The Act includes a provision directing the IRS to issue regulations to address this issue, but is unclear how any such regulations will handle it. Future changes in the law could also address the issue, or make it moot by eliminating the sunset provision or repealing the estate tax altogether.
Impact on Estate Planning
At first blush, it appears that the Act will make federal estate tax planning unnecessary for most Americans. Before these changes, only 0.2% of decedents were subject to the estate tax, or two per 1,000. After the Act, those numbers will be about 0.08%, or eight per 10,000. For now, people with less than $22.4 million don’t have to worry about the estate tax.
But it wasn’t that long ago that people with estates under $1 million had to worry about the estate tax. So the number of wills and trusts that need to be reviewed and revised in light of the changes in the law is enormous. Many of these documents have formula clauses tied to the amount of the exclusion, which could now result in unintended estate dispositions. All of these estate plans should be reviewed in light of the Act.
And the federal estate tax is not the only reason for estate planning. There are state taxes that apply in many situations. There are family circumstances to consider in determining how much to leave beneficiaries and in what manner. Trusts are important to control the disposition of assets even if estate taxes are no longer a factor. For people with under $22.4 million of assets, which is most of them (99.92%), it is still important that their estates are distributed to the right beneficiaries, in the right way.
For people with substantial estates who will still be subject to estate tax with the higher exclusion amount, the planning opportunities are great. Even if they have fully utilized their exclusions with prior lifetime gifts, they now have another $5.6 million to utilize ($11.2 million if married). These gifts can be leveraged with strategies and techniques that estate planners have been using for years, such as grantor retained annuity trusts, sales to intentionally defective grantor trusts, irrevocable life insurance trusts, qualified personal residence trusts and interfamily loans, to name a few.
In 2013, we were told that the $5 million exclusion was permanent. So there is no reason to think the changes in the Act are any more permanent. In the future, we could see anything from full repeal, to the sunset taking effect, to a reduction in the exclusion. People in a position to take advantage of the increase in the exclusion would be well advised to act quickly while it is available, since there is no guarantee it will be here forever, or even for long.