The Implications for Estate Planning

The Implications for Estate Planning

Under the recently enacted Tax Cuts and Jobs Act (TCJA), many people will find that they’re not subject to federal estate taxes, because their estates are worth less than the new exemption equivalent amount.

We’ll explain how the new rules could impact you and what strategies you can use to make the most out of your estate. Detailed strategies will depend on your wealth level and the state in which you live, and we’ve put together some general advice for federal estate taxes alone, based on three relevant situations.

If You're Not Subject to Federal Estate Taxes

How Planning has Changed

Over the last several years, planning has become more tax driven. Since the federal exemption increased from $1 million to more than $11 million, the practice of giving away appreciated property before death has declined. The new approach allows taxpayers to take advantage of the stepped-up basis available for assets held at death, and avoid passing on capital gains taxes to heirs who choose to sell the estate

What to Do

Revisit Old Estate Planning Documents

  • Your documents may have been drafted to split the estate, passing to children the portion that is not subject to estate tax (because of the estate tax credit), and to the spouse (using the unlimited marital deduction) the portion that is subject to estate tax. Such estate plans would have produced the desired result when the estate tax exemption was $1 million. Now an entire estate worth $11,180,000 million or less at the testator’s death would be sheltered by the estate tax exemption, so such a plan would leave it all to the children. Fortunately, updates can address an outdated will or trust agreement.
  • An old estate plan may have a life insurance policy to pay for future estate taxes. If the purpose for life insurance has become less relevant, plan to meet with your insurance advisors to update your approach.

Strategies to Consider

  • Basis planning
    • It might be advisable to retain certain assets or have them included in the estate at death, so they’ll be eligible for a basis step-up. One way to do this is “power of appointment.” With it, any assets over which you hold a “general power of appointment” will be included in your taxable estate and receive a step-up in basis at your death. You may also want to consider an Optimal Basis Increase Trust to qualify assets for this step-up in basis, and possibly avoid a step-down in basis and have lower capital gain taxes on a loss property.
  • Make gifts to parents who have non-taxable estates
    • Those assets will receive a step-up in basis at the parent’s death. Just remember, if you reacquire gifted appreciated property within one year of the transfer, you will not receive a step-up in basis.
  • Valuation discounts may be less valuable than in the past
    • If you are not projected to owe an estate tax, applying the discount could be disadvantageous. You would want the asset to be valued at the step-up cost basis rather than the discounted cost basis.
  • Make a gift during your lifetime rather than through your will
    • Instead of making charitable bequests through your will, for which you will not be able to benefit from the charitable estate tax deduction, you could accelerate the gift during your lifetime and obtain a charitable income tax deduction. Be aware that TCJA rules may make deductions less valuable.

If You Are Projected to Leave Taxable Estates

How Planning has Changed

Today you may be under the $22,360,000 effective combined federal exemption for a married couple given portability, or the $11,180,000 exemption if single, but consider your future wealth. Count the effects of good investment returns and compounding, and remember the “rule” that your invested resources double in 10 years. A current net worth of $5 million could be worth more than $10 million in 2026. If you are 70 and worth $1 million today, appreciation may not be a future concern, but if you’re worth $3 million today and have a lifespan of more than 20 years, your wealth at death could exceed the exemption.

What to Do

Consider Using Gifts to Reduce the Size of Your Potential Estate

In this scenario you would be giving up assets you may want later for long term care. Strategize to use your increased exemption, and retain some level of access to assets.

  • Use the available increased exemption now, or lose it.
  • Plan for a basis step-up. If you’re unlikely to face an estate tax, it might be advisable for you to retain certain assets or have them included in your estate at death so it will be eligible for a basis step-up.
  • Obtain grantor trust status. To do so, add a power to permit the setlor to swap assets from a personal trust in exchange for assets of equivalent value. This could be used to pull highly appreciated assets, with a low basis, out of an irrevocable trust so that they are included in your estate upon death and can achieve a step-up in basis. Then, the basis on which capital gains tax is calculated is reset to fair market value, thus reducing capital gains tax on a future sale.
  • Use an Intentionally Defective Grantor Trust (IDGT). This special grantor trust can be seeded with cash and buy assets from the grantors to increase basis in those assets.
  • Forgive loans to children. If you took advantage of the low interest rates to make an arms-length loan to your child, the increased exemption makes now a good time to forgive that loan.
  • For portability of a spouse’s unused federal estate exemption, a federal estate tax return has to be filed upon the death of the first spouse. With the increased exemption, there may be a push to secure portability now. This way, if the surviving spouse dies after 2025, the first deceased spouse’s potentially larger unused exemption is still available. If the federal exemption returns to its current level in the future, the loss of portability from failure to file an estate tax return at the death of the first spouse can create a greater estate tax upon the death of the survivor.
  • Consider forming non-reciprocal, spousal lifetime access trusts (SLATs). In order to retain access to assets if circumstances change, you could give your spouse a limited power of appointment to appoint assets back to you, take loans, or incorporate life insurance proceeds to provide needed liquidity.
  • Single individuals may consider self-settled domestic asset protection trusts (DAPTs). Assets can be removed from your estate but you can nonetheless remain a beneficiary.
  • The use of annual exclusion gifts many no longer be worthwhile. For many individuals the cost and bother of annual gifts and Crummey power provisions in trusts, may no longer be worthwhile.

If You Have Larger Estates That Will Be Subject to Federal Estate Taxes

How has Planning Changed

For this particular group, it will be planning as usual and augmenting existing plans.

What to Do

Consider using trusts to maximize some benefits introduced in the new tax law. If you incorporate dynastic planning and use generation-skipping tax plans, explore strategies related to the increased generation-skipping tax exemption.

Some strategies being discussed by practitioners are highlighted below. However, guidance has not yet been issued in this area, so we recommend caution when proceeding with these strategies.

Strategies to Consider

  • Increased exemption for larger estates. Likely used in combination with a leveraged transaction, this could maximize the wealth transfer from the increased exemption.
  • Leverage valuation discounts now. IRC Section 2704 Regulations have been withdrawn.
  • Gift strategically. If you have a previous note sale transaction, consider additional seed gifts to the purchasing trusts to strengthen the economics of the transaction. You may also evaluate whether previous guarantees in lieu of seed money for the trust are still warranted.
  • Use a transfer to remove estate assets if you’ve used a rolling Grantor Retained Annuity Trust (GRAT) strategy. The larger exemption will permit a one-time transfer to an irrevocable trust as a completed gift in order to remove assets from your estate.
  • Use a grantor trust to reduce the grantor’s estate without making additional gifts. These trusts also allow trust assets to grow income tax-free.
  • Use the new Section 199A pass-through entity qualified business income deduction. Consider transferring ownership interests from a business to a non-grantor trust, which could potentially shield 20% of pass-through income. Guidance still needs to be issued on this new area of tax law.
  • Minimize the state and local tax (SALT) limitation impact. Use non-grantor trusts to multiply property tax deductions in high-tax states. For example, real estate would be owned by an LLC, and LLC interests and income producing assets would be used to fund non-grantor trusts. The trust must own an intangible asset (LLC interest) not the actual real estate, or you will taint the trust. The LLC would elect out of partnership status, so that the property tax is not reported on a partnership tax return, but on the returns of the separate trusts. Effectively, this could allow the full deduction for the annual property taxes, assuming the trust has enough income to offset the property tax. If there is any question about the potential loss of the Code Section 121 home sale exclusion because the home is owned by a non-grantor trust, you could convert back to grantor trust status if you plan to sell the house so you can meet the 2 of 5 year ownership rules.
  • Consider allocating the increased GST exemption to previously created non-GST exempt trusts. This will allow those trusts to be GST exempt no matter if the GST exemption rolls back down.
  • Address existing irrevocable trusts, because of the increased GST exemption. In irrevocable trusts with inclusion ratios greater than zero and assets that may ultimately pass to skip persons (either by design or due to changed facts), consider making a late allocation of GST exemption where appropriate to have an inclusion ratio of zero.

Remember, as tax laws can always change, the best advice estate planning advice is to incorporate flexibility. Whichever strategies make the most sense for you, keep your options open by using trusts made flexible with trust protectors. These independent people (not beneficiaries or trustees) act in a fiduciary capacity and have the power to remove and replace the trustee, and change situs and governing law of the trust and other powers.

This piece is not intended to provide specific tax or legal advice. You should consult with your own advisors about your particular situation.

Any opinions, projections, or recommendations contained herein are subject to change without notice and are not intended as individual investment advice.

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