TAX REFORM: Estate and Gift Tax Changes Under the Tax Cuts and Jobs Act
By Richard Bloom and Joshua Zimmerman
The recently enacted Tax Cuts and Jobs Act (”TCJA”) included a provision that drastically increased the federal gift, estate and generation skipping transfer tax exemption. The exemption increased from $5 million, indexed for inflation, to $10 million, indexed for inflation.
The 2018 exemption was slated to be $5.6 million ($11.2 million for a married couple). As a result of the Act, the exemption will be approximately $11,180,000 (approximately $22,360,000 for a married couple) for tax year 2018 and will gradually increase, based on inflation, through 2025. The increase in the gift, estate and generation skipping transfer tax exemption sunsets after December 31, 2025, at which point it reverts back to $5 million, indexed for inflation.
The TCJA did not change the gift, estate, or generation skipping transfer tax rate, which remains at 40%.
Although many individuals will not have estates in excess of the lifetime exemption, the recent legislation should prompt individuals – especially individuals who previously developed their estate plans based on the prior exemption amounts – to review and update those plans as needed.
State Estate Tax Issues
A number of states, including New York, Connecticut, and Pennsylvania, impose an estate or inheritance tax on a resident decedent or on decedents that have property located within the taxing state. State estate tax exemptions can be significantly lower than the federal amount. For example, New York State’s current exemption amount is $5,250,000.
Conversely, only one state currently levies a tax on lifetime gifts – Connecticut. Taxpayers that live outside of Connecticut could realize estate tax savings by gifting assets during their life. The gifted assets will generally not be considered part of the decedent’s estate at the state level, thus potentially reducing one’s state estate tax.
Please note, some states include gifts made in contemplation of death in a decedent’s estate (e.g. New York will include gifts made within three years of death in a decedent’s estate for decedent’s dying before January 1, 2019).
As a result of the disparity between state estate tax exemption amounts and the federal estate tax exemption amount, a decedent’s estate may unexpectedly owe state estate taxes. Consequently, careful consideration must be given to state estate taxes even though one’s federal taxable estate is below the federal estate tax exemption.
 These amounts are approximations and are subject to computation and announcement of the actual inflation adjusted amounts by the Internal Revenue Service
Credit Shelter Trusts
Traditionally, estate planning has utilized an individual’s remaining federal exemption at death by providing that an amount equal to decedent’s remaining federal exemption be placed into a trust (commonly referred to as a “credit shelter trust”) at the death of the first spouse to die. This trust is typically designed to provide for the surviving spouse during life, and then for the children and grandchildren. However, this trust is designed to not be eligible for the unlimited marital deduction. Assets in excess of the decedent’s lifetime exemption would generally pass directly to the surviving spouse or a trust for the surviving spouse and, unlike the credit shelter trust, will be includible in the surviving spouse’s estate.
Taxpayers should review their estate planning documents and financial situation to determine whether they are financially comfortable funding a credit shelter trust with assets equal to the higher exemption amount. Additionally, the funding of the trust with the newly increased exemption amount could result in additional state estate tax that would otherwise be avoided if passed directly to a surviving spouse.
Consider a married couple, living in New York, with joint assets of $30,000,000. Neither individual has gifted during their lives, and each has their entire lifetime exemption remaining. The husband dies in 2018, owning $15,000,000 in assets and his Last Will and Testament provides that a credit shelter trust will be established for an amount equal to the federal lifetime exemption remaining at his death, with the remainder passing directly to his spouse.
At death, the husband’s estate will incur approximately $1.255 million of New York state estate tax on the $5,930,000 ($11,180,000 less $5,250,000) passing to the credit shelter trust in excess of the New York state exemption. Conversely, if he had updated his estate planning documents to recognize the difference between the federal and state exemption amounts, the husband’s estate could defer the payment of state estate tax on the amount in excess of the New York state exemption by funding the credit shelter trust with assets equal to the New York estate exemption amount and utilizing portability to maximize use of his federal exemption amount.
In addition to gift, estate and generation skipping transfer tax, individuals should pay special attention to how income resulting from the sale of a gifted or bequeathed asset may be taxed to the donee/heir. Generally, income tax is levied upon the gain realized on disposition of the asset. A seller’s basis is normally determined as the price the seller paid to acquire the asset, including certain additions and subtractions during the ownership period. An asset transferred to an individual during the life of the donor retains the donor’s basis while assets transferred at death get “stepped up” to the fair market value on the decedent’s death. As such, individuals should be cognizant of unrealized gains inherent in assets that may be gifted and, in some circumstances, plan to give gifts with basis near, or equal to, the fair market value on the date of the gift.
John’s taxable estate consists of one asset – Apple stock with a value on his date of death of $10,000,000. John’s cost basis in the stock is $1 million. If John gifts the stock to his son, his son would have a cost basis in the stock of $1 million. Assuming John’s son sells the stock shortly after John’s death when the market value has not changed, John’s son would owe capital gains tax on $9 million ($10 million sales price less $1 million cost basis). This tax could equal $1.8 million plus net investment income tax and state income tax.
Alternatively, if John held the Apple stock until death and bequeathed it to his son, his son would have a cost basis of $10 million. This means that his son would not owe any capital gains tax, net investment income tax or state income tax if he sold the Apple stock for $10 million. In addition, John’s estate would not incur any estate tax since John’s estate tax exemption (approximately $11.18 million) exceeds his taxable estate of $10 million.
This oversimplified example highlights the need to even more closely consider the income tax effects of estate planning.
Spousal Lifetime Access Trusts
Many individuals may be hesitant to fully utilize their gift tax exemption (approximately $11.18 million) since they feel they may need access to these assets at some point during their lifetime. To address this issue, a spousal lifetime access trust (SLAT) can be utilized.
This type of trust gives the trustee the power to make distributions to the grantor’s spouse in his/her discretion. Consequently, as long as the grantor remains married and the grantor’s spouse is alive, the marital unit (husband and wife) has indirect access to the funds in the SLAT at the discretion of the trustee.
Planning for Estates in Excess of Increased Exemption
Taxpayers whose taxable estates exceed the increased exemption amount should move forward with estate planning. These taxpayers can continue to use existing techniques such as grantor retained annuity trusts, sales to defective grantor trusts, intrafamily loans and dynasty trusts.
Please contact your Mazars USA LLP professional if you have any questions.