Estate and Gift Tax Planning
Wolters Kluwer Reviews Major Changes to Federal and State Estate and Gift Tax Rules
(NEW YORK, NY, January 2018) — The year begins with a bang following passage of the Tax Cuts and Jobs Act – the most comprehensive series of tax law changes in decades – including a major change to federal estate and gift taxes.
Updates for 2018 Estate and Gift Taxes
Although the House’s version of the 2017 Tax Cuts Act had included the complete elimination of the estate and generation-skipping transfer (GST) tax, the final package that emerged from the Conference Committee followed the Senate’s proposal. Consequently, the estate, gift, and GST taxes all remain in force in 2018. Instead, the basic exclusion amount for purposes of the estate and gift tax and the corresponding exemption amount for purposes of the GST tax is doubled from $5 million to $10 million before adjustment for inflation. However, due to budgetary constraints in drafting the legislation, this change is only temporary in that it will expire after 2025.
Before passage of the 2017 Tax Cuts Act, the IRS had announced the inflation-adjusted lifetime estate tax basic exclusion amount for decedents dying and gifts made in 2018 would be $5.6 million – meaning that estates valued at that amount or lower would be excluded from estate taxes (up from $5.49 million for 2017). Accordingly, the doubling of the exclusion amount by the new law would have raised that amount to $11.2 million per person and, the estates of a married couple could potentially exempt twice that amount, up to $22.4 million from estate or gift taxes for 2018 transfers. But the 2017 Tax Cuts Act made a significant change to the way inflation adjustments are calculated for many provisions in the Internal Revenue Code, including with respect to estate and gift taxes. This change uses a different measuring device called the Chained Consumer Price Index for All Urban Consumers (C-CPI-U) to gauge inflation. Because the C-CPI-U reflects inflation at a somewhat slower rate than the previous methodology, we expect the lifetime basic exclusion amount for 2018 will actually be somewhat less than $11.2 million per person and $22.4 million available for a married couple.
Another important figure that is indexed for inflation is the annual gift tax exclusion, which has remained at $14,000 for several years. For 2018, tax-free gifts of up to $15,000 per donee will be permitted or $30,000 per couple using gift splitting.
“The fact that the doubling of the lifetime exclusion will expire in a few years means that wealthy families who would otherwise be impacted by the estate tax have an unprecedented opportunity for making large gifts in the coming years,” said Bruno Graziano, JD, MSA and Senior Estate Tax Analyst for Wolters Kluwer Tax & Accounting. “In addition, the new law left untouched the stepped-up basis at death. There had been some concern prior to passage of the legislation that it would include a change to a carryover basis system or, perhaps, some form of capital gains tax at death. Leaving the stepped-up basis rule in place means that heirs will not have to research the historical basis of long-held assets and will only be taxed on the appreciation in those assets that takes place after the deceased former owner’s death.”
State Estate Tax Developments
Although many states have historically based their estate tax laws on the federal estate tax, some states have passed their own “stand-alone” estate tax laws as a way of holding onto tax revenues. They include Connecticut, Hawaii, Maine, Minnesota, New York, Oregon, Rhode Island, Vermont and Washington State. Several other states still have pick-up taxes that seemingly would apply, but because their laws remain geared to the repealed federal credit for state death taxes, no taxes are collected under these laws.
Ten states have no estate tax at all: Arizona, Delaware (repealed in 2018), Georgia, Indiana, Kansas, New Jersey (repealed in 2018), North Carolina, Oklahoma, South Dakota and Texas. Other states, such as California and Florida technically still have a tax on the books, but their taxes are based on the now-repealed federal credit for state death taxes and it is highly doubtful that the federal credit will ever be reinstated. Consequently, those states do not tax the transfer of an estate either.
In addition to estate taxes, six states also collect an inheritance tax. This is a tax on the portion of an estate received by an individual. It is different from an estate tax, which taxes an entire estate before it is distributed to individual parties. These states are Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. Assets transferred to a spouse are exempt from inheritance taxes and some states exempt assets transferred to children and close relatives.
The Tax Cuts and Jobs Act did not change the rate structure for estate and gift tax, which has been in place since passage of the American Taxpayer Relief Act (ATRA) of 2012. Accordingly, the maximum estate tax rate remains 40 percent.
Rules for Surviving Spouses and Portability
Similarly, surviving spouses are still eligible for the benefits offered by “portability” of the estate tax exclusion amount. However, in order to take advantage of portability, the estate of the first spouse to die must decide whether they want to make the portability election and file a federal estate tax return (Form 706), even if one would not otherwise have been required.
For example, if one spouse died in 2018 after using only $4 million of his exclusion for lifetime gifts, his wife would still have her more than $11 million exclusion (or a higher amount depending on the inflation adjustment in the year of her death) as well as the remaining amount of her husband’s exclusion, which is not indexed for inflation beyond the year of his death. The remaining exclusion would also be available to the surviving spouse for gift tax purposes.
“While the portability may cause some decedent’s estates to consider filing an estate tax return to claim portability, many estate planners believe more traditional strategies may be more effective,” Graziano added. “Also, the estate tax return (Form 706) is very lengthy, with multiple schedules and involves valuation issues and complex tax laws that can make it very cumbersome and expensive to complete. And, with the large increase in the lifetime exclusion available beginning in 2018, fewer and fewer estates would be required to file an estate tax return.”
Additional Key Points on Estate Taxes and Portability
- Estates have up to 9 months after a person dies to file an estate tax return, but can, and often do, request a six-month extension.
- Estates that fall below the exclusion amount are not required to file Form 706, but they must do so in order to make the portability election.
- Portability amounts are not indexed for inflation that occurs after death. As a result, a spouse who survives considerably longer could see assets appreciated beyond the available estate tax exclusion amount. Accordingly, any amount in excess of that amount could now be subject to tax at 40 percent.
- If a spouse remarries or has additional children, he or she can decide where the property will go; which may not be the same intentions of the decedent spouse.
- Assets are not protected from creditors.
“Despite the addition of portability, at least some estate planners still favor using traditional credit shelter trusts to address these issues,” Graziano pointed out. “But establishing and maintaining such trusts can also present certain costs.”