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Financial Planning > Tax Planning > Tax Reform

Tax Changes to Estate Plans Still Need to Be Scrutinized

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Even though 2018 is over, many clients should still take the time to evaluate their current estate plans and look ahead to the next few years to evaluate how recent tax law changes have impacted the continued viability of existing strategies and opened the door for new opportunities.

While the estate tax-related provisions implemented by the 2017 tax reform legislation may seem simple on their face, the actual impact of the expanded transfer tax exemption can have far-reaching implications as to clients’ existing estate plans.  With proper planning and advice, clients can enter the new year knowing that they are not leaving any tax savings opportunities on the table.

Lifetime Gifting Strategies

Under the 2017 tax reform legislation, the estate, gift and GST exemption amount was roughly doubled to $11.18 million per individual, and will be adjusted upward to $11.4 million for 2019. Despite this, the provision was made temporary, so that the exemption will revert to its pre-reform level of about $5.6 million in 2026. This has generated many questions as to how large lifetime gifts made before 2026 will be treated—in other words, whether the IRS will impose a “clawback” provision to tax gifts made in excess of a lower future exemption.

The IRS and Treasury answered these questions with proposed regulations to clarify that if individuals make large gifts between 2018 and 2025 in reliance on the enlarged exemption, they will not be punished if, after 2025, the exemption is allowed to revert to pre-reform levels.

In general, the transfer tax exemption is first applied to exempt lifetime gifts, and then applies to the individual’s remaining estate.  Under the proposed regulations, an estate will be permitted to calculate the dollar value of exempted transfers using the higher of the amount that applied to gifts made during life, or the amount applicable as of the individual’s date of death.

Because of this new rule, wealthy clients should consider lifetime gifting strategies that take advantage of the currently high exemption.  Many of these clients may wish to employ a strategy that makes large gifts over the eight-year period in which the enlarged transfer tax exemption will remain in effect.

Evaluating Stepped-Up Basis Rules

The expanded estate tax exemption has created a new complication for clients who have implemented estate plans designed to secure valuation discounts with respect to assets that could potentially be included in their gross estate. For example, clients often create family limited partnerships (FLPs) because of the potential valuation discounts that may be available.

FLPs are often created to reduce estate taxes, but the doubled estate tax exemption from 2018-2025 may mean that these clients will no longer be subject to the estate tax at all. Unfortunately, use of the FLP structure will require the client to forego the step-up in basis that the assets transferred to the FLP would otherwise receive upon his or her death. If the client who formed the FLP no longer anticipates being subject to the estate tax, he or she may wish to dissolve the FLP in order to obtain that step-up in basis and allow his or her heirs to realize the income tax savings that the step-up can generate.

Of course, the value of this strategy will depend upon the overall health (i.e., life expectancy) of the client and whether the estate tax exemption eventually reverts to its pre-reform levels. Clients interested in dissolving their existing FLPs should also be aware of the potential for taxation under IRC Section 731 if the FLP distributes cash or marketable securities in excess of basis, in which case the distribution will be treated as ordinary income in some cases.

Evaluating GRAT Assets and Rising Interest Rates

Clients who have contributed assets to a grantor retained annuity trust (GRAT) should evaluate the basis of those assets and consider exchanging those assets if necessary. A GRAT combines a trust that is established for a certain predetermined period of time with an annuity that pays the grantor a set value each year of the trust’s existence. This annuity payout is the client’s retained interest. The remaining value passes to the client’s beneficiaries, and out of his or her estate.

The value of the taxable gift to the GRAT beneficiaries is equal to the fair market value of the GRAT property minus the client’s retained interest. The retained interest is the actuarially calculated value of the annuity stream the client will retain over the GRAT’s life based on the Section 7520 rate in effect for the month when the GRAT is created.

For the GRAT to succeed, tax-wise, the assets placed into the trust only need to outperform that locked-in Section 7520 rate. If a client’s assets are locked into the GRAT at today’s low interest rates, the probability of the assets appreciating at a more rapid rate as interest rates increase also increases. Generally, a client is able to exchange or buy-back GRAT assets for fair market value, so a year-end checkup of the assets placed in the GRAT and potential tax value of exchanging those assets can be valuable to clients who have employed this planning strategy.


Clients who regularly engage in estate planning “check-ups” may think that there is no need to “rush” any of the strategies that can be employed based on the currently high estate tax exemption or rising interest rates, but they should be advised that tax laws can change at any moment—making flexibility key to any estate plan’s ability to maximize the value of the tax law changes over the long term.


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