Tax Reform Series: Estate & Transfer Taxes
The 2017 Tax Act did not repeal the federal estate, generation-skipping transfer, or gift tax. The Act does, however, double the basic exclusion amount from $5 million to $10 million per person. The indexed exclusion amount is estimated to be $11.18 million per person or over $22 million per couple in 2018. In other words, far fewer Americans will need to be concerned with such taxes until 2026 when the exclusion reverts to prior law.
During the period the basic exclusion is doubled (2018-2025), many wealthy clients will consider making large gifts significantly over and above the annual gift tax exclusion ($15,000 per recipient in 2018). The higher exclusion presents a limited time opportunity to consider whether larger lifetime gifting is appropriate. Such gifts can impact the federal estate and generation-skipping transfer tax burden upon death, state estate and inheritance taxes, or even state income taxes during your lifetime.
There are any number of impactful gifts that should be considered based upon each client's goals and circumstances. For example, consider simply forgiving an outstanding loan to a child. This action can reduce your taxable federal and state estate size. Alternatively, perhaps you are no longer worried about federal or state estate taxes, because you are below the federal exclusion amount, and your state has no estate tax. Make sure to determine whether your state has an inheritance tax (e.g. NJ inheritance tax rates range from 11 to 16 percent when applicable). The inheritance tax might be avoidable by making a lifetime gift to the same person instead of leaving them assets upon your death. Many clients, unsurprisingly, are seeking ways to reduce state income taxes. The higher basic exclusion might offer the chance to fund a certain type of trust for purposes of shifting income generated by the gifted assets to another state with low, or no, income tax.
Tax planning techniques that employ lifetime gifts should only be considered following thorough assessment of the impact of a potential clawback of the value gifted for estate tax purposes. Caution is specifically advised, because the Act directs the Treasury to prescribe regulations necessary to address any difference in the exclusion amount at the time of gifting and time of death (e.g. making a $6 million gift in 2018 while the basic exclusion is $10 million before dying in 2026 when the basic exclusion is back to $5 million). Those regulations are still yet to be proposed.
Perhaps more important than the risk of clawback, is determining whether the estate tax savings of gifting are even merited. There is no basis-step up at death for assets no longer owned (i.e. gifted away). Obtaining a basis stepped up to fair market value may be very important to the donee in terms of federal income tax consequences after your death. Therefore, it remains advisable to be very strategic in gifting, to avoid transferring assets with a low basis, and to always consider income tax outcomes in the context of estate planning.
Just FYI Travis Scales is a tax attorney focused on efficient wealth accumulation and preservation strategies.