On November 2, 2017, the House introduced the highly anticipated Tax Cuts and Jobs Act (“TCJA”). If enacted in its current form, the TCJA would be the largest tax overhaul since 1986. This Article will address certain provisions of the proposed legislation that impact estate planning.
The TCJA generally maintains the current transfer tax regime through 2023, but provides for the doubling of the estate, gift and GST tax exemptions from $5 million to $10 million for decedents dying, and transfers made, in 2018 through 2023. The $10 million exemptions are adjusted for inflation using 2010 as the baseline year, which means the exemptions actually would be materially higher than $10 million beginning in 2018. The portability rules remain in place, thereby permitting a married couple to shelter over $20 million from transfer taxes. After 2023, the estate and GST taxes are repealed, but the gift tax remains in effect with the increased lifetime exemption and a reduced top rate of 35%.
Although the estate tax would be repealed under the TCJA for decedents dying after December 31, 2023, it is possible that qualified domestic trusts (QDOTs) could still incur an estate tax after that date if the QDOT was created upon the death of a decedent dying prior to 2024. A QDOT is a trust used to qualify transfers to noncitizen spouses for the estate tax marital deduction. Under current law, the practical effect of the QDOT is to postpone payment of the estate tax due at the decedent’s death until the funds are distributed from the QDOT to the surviving spouse or the surviving spouse dies. Under the TCJA, the QDOT would not incur estate tax if the surviving spouse dies after December 31, 2023; however, distributions from a QDOT made to the surviving spouse on or before December 31, 2033 would still trigger estate tax. Thus, you may see QDOTs withholding distributions to surviving noncitizen spouses during this ten year window in order to avoid incurring an estate tax.
It was widely thought that a casualty of repealing the estate tax would be a loss in the stepped-up basis rule under Section 1014 for income tax purposes. The TCJA, however, provides that the assets that would have been included in the decedent’s gross estate if there was an estate tax continue to receive an income tax basis equal to fair market value on the decedent’s death. Thus, appreciated assets held at the death of a decedent that would receive a stepped-up basis under current law would continue to receive a stepped-up basis, thereby eliminating tax on the unrealized appreciation. While the estate tax only affects a small percentage of the population, maintaining the Section 1014 stepped-up basis is vitally important to all taxpayers, regardless of wealth, who pass away owning appreciated property.
As mentioned above, the TCJA does not provide for a repeal of the gift tax even though the estate and GST taxes are repealed beginning in 2024. The gift tax regime supports the income tax base by preventing taxpayers from temporarily shifting wealth to other family members who are in lower tax brackets. For example, parents who find themselves in the 39.6% tax bracket could transfer income producing assets to their 25 year old child who may pay taxes at a far lower rate. Without a gift tax regime, assets could be freely transferred back and forth between family members to save income taxes. The TCJA reduces the gift tax to an afterthought for most Americans, however, by doubling the exemption to $10 million indexed for inflation and maintaining the annual exclusion ($15,000 per donee in 2018). For those who make gifts exceeding their exemption, the top rate is reduced from 40% to 35%.
Much has been made of the changes in personal income tax rates under the TCJA. One byproduct of these rate adjustments is a corresponding change in the income tax rates applicable to estates and non-grantor trusts. Specifically, estates and trusts under current law have rate brackets of 15%, 25%, 28%, 33% and 39.6%. Under the TCJA, estates and trusts would see brackets of 12%, 25%, 35% and 39.6%. The income threshold at which the 39.6% top rate applies would decrease by $200 for 2018 to $12,500 and be indexed for inflation thereafter. The personal exemptions applicable to estates and trusts would be replaced with a basic deduction, but the deduction amounts would remain unchanged ($600 for estates; $100 for complex trusts; $300 for simple trusts that require all income to be distributed).
Charitable giving also often comprises an important part of a family’s estate plan. Under current law, individuals generally may claim an income tax deduction for up to 50% of their contribution base (i.e., adjusted gross income less net operating loss carrybacks) for contributions to public charities. TCJA increases the 50% cap to 60% for contributions to public charities that are made in cash, thereby providing an additional income tax benefit for philanthropic families.
Thursday’s release of TCJA was the first opportunity the public and many in Congress have had to review the text of the proposed tax legislation. Although it is interesting to review the bill in its current form, there almost certainly will be changes prior to its enactment despite the efforts of some to rush this bill through. Lobbyists and legislators are also likely to spring into action in an effort to add last minute amendments that serve the interests of their clients and constituents.
Considering the lack of Democratic support for, and the razor thin majority of Republicans in favor of, the budget resolution, it remains to be seen whether the TCJA, or any significant tax legislation for that matter, will be able to garner the support of a majority of legislators in either the House or the Senate. Even the budget resolutions that set the stage for this tax legislation only passed with slim majorities in the House and Senate. The Senate approved their budget resolution providing for $1.5 trillion in tax cuts on a 51 to 49 vote along party lines. The House passed the Senate approved budget resolution on a 216 to 212 vote, with 20 Republicans voting against the resolution. Furthermore, the repeal of the estate and generation-skipping transfer taxes will be subject to the Byrd rule that requires the affirmative vote of 60 Senators to make the repeal permanent. The repeal of the estate tax has a history of being a last minute bargaining chip. It seems highly unlikely, however, that 60 Senators will vote for the permanent repeal of the estate and generation-skipping transfer taxes, which means the estate and GST taxes could return after 2027 when the budget window sunsets.
About the Authors:
Matthew J. Ahearn is Board Certified in both Wills, Trusts & Estates and Tax Law by The Florida Bar Board of Legal Specialization. He has extensive experience in the areas of estate and business succession planning, asset protection planning, charitable planning and planning to minimize or avoid wealth transfer taxes. Mr. Ahearn handles all aspects of probate and trust administrations, including estate and gift tax audits before the Internal Revenue Service. He represents both beneficiaries and fiduciaries in contested matters. He may be reached at email@example.com.
Brian M. Malec is a shareholder in Dean Mead’s Orlando Office. He is Board Certified in Wills, Trusts and Estates. He handles all aspects of estate and succession planning, including the implementation of wills, trusts, business entities and sophisticated estate planning techniques to protect and transfer wealth among individuals and families while minimizing income, gift, estate and generation-skipping transfer taxes. Mr. Malec also handles all aspects of probate and trust administration, including advising fiduciaries throughout the administrative process and representing beneficiaries seeking to assert their rights in an estate or trust. He may be reached at firstname.lastname@example.org.