The Tax Cuts and Jobs Act (TCJA) signed by President Trump in December creates the most sweeping changes to tax legislation since President Reagan signed the 1986 Tax Reform Act into law. While the TCJA changes to the Estate and Gift Tax sector are few, they still bring with them significant uncertainties and opportunities.
Changes to the estate and gift tax
The TCJA increases the amount of the estate, gift and generation skipping tax exclusion from $5 million (unindexed) to $10 million effective January 1, 2018. For 2018, the exclusion per person leaps from the 2017 exclusion amount of $5.49 million to approximately $11.2 million with indexing. This means that a married couple now has over $22 million of exclusion.
Unlike some other sections of the TCJA, the increased estate, gift and generation-skipping tax exclusion has a sunset provision. For deaths and transfers after December 31, 2025, the exclusion amount reverts to pre-2018 levels with indexing applied. In other words, the 2026 exclusion will be roughly half of the 2025 amount.
Along with this sunset provision, the TCJA has also considered the situation where there could be a “clawback” resulting from the disparity between the exclusion amount at the time of gifting and the exclusion amount at the date of death. The TCJA gives the Treasury Secretary legislative authority to write additional regulations to avoid the imposition of estate tax in this circumstance.
The recent legislation and current political climate create many uncertainties regarding estate and gift tax planning. For instance, while the increase in the exclusion amount is set to sunset on January 1, 2026, there remains the possibility that an earlier sunset could occur with a change in administration. In addition, how and when the Treasury Secretary deals with the potential “clawback” due to the reduction in the exclusion amount remains to be seen.
Another area of uncertainty is how states will respond to this new legislation. Currently, New York State does not have a gift tax but taxable gifts made 1) after March 31, 2014 and before January 1, 2019 AND 2) within three years of death, are pulled back into the taxable estate. Also occurring on January 1, 2019, the New York estate tax exclusion is set to equal the federal exclusion. However, this provision is anchored to the federal exclusion as it existed on January 1, 2014, adjusted annually for inflation. This means that the New York exclusion will tie to whatever the federal exclusion would be at that time based on the 2014 amount, indexed. The current New York estate tax exclusion is $5.25 million.
The TCJA’s increase in the basic exclusion amount means that an individual can now pass up to $11.2 million in assets to his loved ones completely free of estate taxes. For a married couple, this amount doubles to $22.4 million. The increase in the exclusion amount means that the number of people who are exempt from the estate tax has greatly increased. According to the Tax Policy Center, in 2018 only 1,700 estates will be subject to the estate tax. This is down from approximately 5,500 taxable estates in 2017.
While the current law may mean that very few estates are taxable, the sunset provision requires diligent planning over the next eight years. Many taxpayers, particularly those with closely-held businesses, may find themselves in a taxable situation when the exclusion amount reverts back in 2026—or sooner due to political changes. In the meantime, they could find that their estate might not be distributed in the way they intended. Perhaps more goes into trust, or one trust versus another, than desired due to formulas in the will. The time to review and plan is now.
The current increased gift tax exclusion amount provides a window of opportunity for wealthy taxpayers to move a large portion of their assets to the next generation tax-free. In fact, the accompanying increase in the GST exclusion also makes it possible to gift to grandchildren tax-free as well. Those planning to gift assets should bear in mind that gifts have a carryover basis (the recipient receives the donor’s tax basis in the gift) and should consider gifting high basis assets whenever possible. Those with smaller estates should think twice before gifting appreciated assets. The TCJA did not alter the basis step-up at death. Therefore, lower basis assets retained until death will obtain a step-up to fair market value at the decedent’s death and capital gain on the unrealized appreciation averted.
Since New York State currently does not have a gift tax, gifts may escape New York transfer tax completely after January 1, 2019, or if made more than three years before death. Again, no one can be sure what changes New York will make to its legislation in response to the TCJA.
For those taxpayers still facing a significant estate tax bill despite the increased exclusions, the same wealth transfer planning techniques that have been used in the past will continue to be effective under the new law. There is a large variety of estate tax planning techniques available depending on each individual’s facts and circumstances. Many employ techniques to freeze asset values in order to maximize the value of exclusion amounts.
The estate and gift tax provisions are but a small part of the TCJA. Given the uncertainties and numerous other complicated provisions included in the new tax legislation, clients should consult their advisors to determine the best estate and gift tax planning techniques for their tax and financial situation.