How Does the New Tax Law Affect Your Estate Plan?

In December 2017, President Donald Trump signed a new tax bill into law. Known previously as the "Tax Cuts and Jobs Act," the reform will have far-reaching impacts on many areas of tax and financial planning. One significant area of impact is estate planning.

Changes Under the Tax Reform

The tax reform legislation raised the estate tax exemption to $11.18 million per person and $22.36 million per married couple for 2018. That was a significant increase over prior limits. The estate tax exemption for an individual is $12.06 million in 2022 and $12.92 million in 2023 (an increase to account for inflation). This eliminates any federal estate taxes on amounts under those limits gifted to heirs during your lifetime or left to them upon your death.

The new legislation effectively eliminates the federal estate tax for all but the wealthiest individuals. One caveat is worth noting: as with most of the provisions of the act, these rules are set to expire at the end of 2025. At that time, the exemption amounts will revert back to previous levels, adjusted for inflation.

Generation-Skipping Tax

The generation-skipping tax (GST) rate exemption also increased to the same amount as above for individuals and married couples. This increase also expires at the end of 2025.

Finally, the method used to calculate inflation on these exemptions and other related areas has been changed. Now, instead of the traditional Consumer Price Index, which was previously used, inflation and exemptions will be calculated based on the Chained-CPI, a modified measure of inflation that adjusts for "situation bias," or accounts for the shifting purchasing behaviors of consumers. The Chained-CPI generally yields a lower rate of inflation.

What This Means for You

The temporary increase in the exemptions for the federal estate tax and the GST means that until the end of 2025 (unless Congress repeals or extends these rules), many will be able to give away more of their estate to their heirs without paying estate taxes. For beneficiaries, the new law has obvious benefits, but its introduction doesn't eliminate the need for estate and tax planning.

Consider These Issues

The most recent tax reform did not repeal the estate tax for those states that assess one. If you live in one of the following states, your assets will still be subject to the appropriate level of any state-imposed estate tax:

• Connecticut
• District of Columbia
• Hawaii
• Illinois
• Maine
• Maryland
• Massachusetts
• Minnesota
• New York
• Oregon
• Rhode Island
• Vermont
• Washington

Additionally, with many states facing substantial fiscal challenges, it’s not beyond the realm of possibility that some states that currently don’t have an inheritance tax might consider enacting one in the future.

Individuals facing state-level estate taxes should consider tactics such as a disclaimer and a bypass trust, or a qualified terminable interest property (QTIP) trust, both of which allow a degree of flexibility in the allocation of the assets in your estate, in order to minimize the impact of taxes on their estate.

With the increased exemption limits, lifetime gifts of estate assets can be made without concern of triggering federal gift and estate taxes, except for those with estates in excess of the exemption amounts. Gifting can also be done with an eye toward shifting assets likely to experience high levels of appreciation. This can shield the appreciation of those assets from future estate taxation in your estate once the current exemption limits expire after 2025.

It's worth noting that lifetime gifts are not entitled to a step-up in cost basis as with assets transferred to heirs upon your death. This means that before gifting appreciated assets like shares of stock, be sure to consider the tax impact upon the recipient of the gift.

A Strategy to Protect a Spouse

One tactic to consider in some cases is the spousal lifetime access trust (SLAT). The SLAT is an irrevocable trust that removes the assets from an individual’s estate but transfers the assets to an irrevocable trust for the benefit of their spouse. The benefit is that those assets are out of the individual’s estate, allowing them to take advantage of the increased estate tax exemption prior to the 2025 deadline, while still retaining a degree of control over those assets via their spouse during their lifetime.

SLATs do have downsides. Should the couple divorce, the grantee has no claim to the assets in the SLAT. It is also critical to ensure that, should both spouses use a SLAT, the trusts are not identical. This helps to avoid the risk that the trusts will be deemed to be substantially identical, in violation of the “reciprocal trust doctrine,” which could invalidate the trust.

Accidental Disinheritance

One potential unintended consequence of the higher exemption limits is that some heirs may unintentionally be disinherited. Many estate plans are set up to use a bypass trust, which directs a trustee to use any remaining estate tax exemption amount to fund the bypass trust. This would be done before distributing the remaining assets in the estate to the intended heirs.

The size of the bypass trust in a case like this could cause some heirs to be unintentionally disinherited. Those with this type of provision should review their estate planning documents.

The Life Insurance Option

Life insurance policies have been a popular way to help heirs cover any estate taxes that might be due in conjunction with a large estate in excess of the exemption limits. With the increase in the exemption, the prevalence of these exemptions may wane.

These policies can now serve as a backstop for the estate, allowing grantors to pass assets in a tax-efficient manner and providing liquidity in cases where some of the estate assets are illiquid, such as real estate or an interest in a business.

The Bottom Line

Tax reform has resulted in many changes for taxpayers, beginning with the 2018 tax season. Estate planning is one area that has been impacted, but like most of the tax reform legislation, the impact is temporary and will largely revert to the prior rules after 2025.

Especially for those with larger estates, it is wise to review your current estate planning documents to ensure that they still do what you intended for them to do and to ensure that you are taking full advantage of any opportunities under tax reform.