The Tax Cuts and Jobs Act (“Act”) was signed into law on December 22, 2017. The Act made a number of changes to the income tax rules, as well as the estate, gift, and generation-skipping transfer (“GST”) tax rules.
In this publication, we discuss the changes to the estate, gift, and GST tax rules under the Act. For the most part, we will not discuss the income tax law changes; you should discuss those changes with your accountant.
No Repeal; Exemption Limits Doubled Until End of 2025
The Act did not repeal the estate, gift, and GST taxes. Instead, the Act temporarily doubled each person’s separate estate, gift, and GST tax exemption to $10 million per person, adjusted to the equivalent of 2011 dollars. This means that effective January 1, 2018 each person’s tax exemption became approximately $11.2 million[1] reduced by any exemption amount the person previously used.
The increase in the tax exemption amounts is scheduled to sunset after December 31, 2025.
The tax rate remains unchanged at 40%.
Claw Back
Prior to December 31, 2025, some donors will take advantage of the temporary increase in his or her lifetime gift tax exemption by making large gifts to children or other loved ones, either outright or in trust. Most commentators believe that for donors who make large gifts between 2018 and 2025, but who die after 2025 (when each individual’s lifetime gift tax exemption reverts back to their pre-Act levels), those gifts in excess of the donor’s lifetime gift tax exemption amount in effect after 2025 will not be “clawed-back” to the donor’s taxable estate and made subject to federal estate tax. However, we will not know for sure until the Treasury issues regulations.
No Changes to Portability Rules
Portability remains in effect under the Act. With “portability,” if a deceased person is survived by a spouse, any remaining estate tax exemption that was not used by the deceased person’s estate may be transferred to his or her surviving spouse and added to the spouse’s exemption for estate tax purposes.
If death occurs between 2018 and 2025, it is unclear if the increased exemption amount under the Act would be portable if the surviving spouse dies after 2025 when the temporary increase to the tax exemption amounts under the Act sunsets. We also expect the Treasury to issue regulations to clarify this issue.
Note that portability does not apply to a deceased person’s unused GST tax exemption.
No Changes to Income Tax Basis Rules for Lifetime Gifts or Basis Step-up on Death
The Act did not change the rules for an asset’s income tax basis (also known as its cost basis) transferred by the donor, either during lifetime or upon the donor’s death. An asset’s income tax basis is used to determine the amount of any capital gain (or loss) upon any future sale of the asset.
Generally, the recipient of property transferred during a donor’s lifetime would receive the donor’s adjusted cost basis for the asset. By contrast, when a beneficiary inherits property from a decedent, generally the cost basis of the asset is adjusted to equal its fair market value as of the decedent’s date of death. If an asset has appreciated during the decedent donor’s lifetime, this will usually result in a “step-up” in the income tax basis of the property at death. The above income tax basis rules should be considered prior to making gifts of appreciated property.
Pass-Through Entity Planning
Among other income tax changes, the Act creates a new income tax deduction of up to 20% for pass-through businesses – sole proprietorships, S-corporations, partnerships, or limited liability companies taxed as partnerships – on “qualified business income” (QBI). The deduction is subject to certain limits and restrictions. This new deduction creates a planning opportunity for clients who can qualify for the new deduction by establishing a pass-through entity.
Our firm does not provide income tax advice of this nature. You should consult with your accountant on whether or not to establish a limited liability company or other pass-through entity to qualify for the new deduction.
Conclusions and Planning Considerations
- This significant and temporary increase in each person’s lifetime gift tax and GST tax exemption amounts presents a unique opportunity for making lifetime gifts to children or other loved ones, either outright or to existing or new gift trusts.
- It is a good idea to review your estate plan to determine if it continues to accomplish your wishes. For example, if your current Revocable Living Trust calls for the size of your gift to be tied to the lifetime exemption in effect at the time of your death, you may wish to review and potentially change such gift formula in your trust.
- In some cases, one spouse owns significant separate property while the other spouse has comparatively less property. Making a gift in the coming years to leverage the increased gift tax exemption possessed by the other spouse would be an excellent way to help the spouse with the larger estate transfer gifts to loved ones free of estate and gift tax.
- Those of you who might qualify for the new income tax deduction of up to 20% for pass-through businesses should speak to your accountant regarding that aspect of the Act, as well as any other income tax changes that may affect your personal income tax planning.
[1] The Act changes the way inflation adjustment is calculated in the Internal Revenue Code, and each person’s estate, gift and GST tax exemption amounts will likely be $11.18 million in 2018. However, this figure may not be finally determined until the end of 2018 or even early 2019.
This alert should not be construed as legal advice or a legal opinion on any specific facts or circumstances. This alert is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The contents are intended for general informational purposes only, and you are urged to consult your attorney concern any particular situation and any specific legal question you may have.
