Flexibility in estate plans needed due to sunset of Tax Act provisions

The Tax Cuts and Jobs Act of 2017 (the “Act”) significantly increased the exemption amounts for the gift, estate and generation-skipping tax (GST) purposes. For 2017, each of the exemptions was made up of $5,000,000 of basic exclusion and $490,000 of inflation adjustment.

For 2018, the basic exclusion is $10,000,000 and the inflation adjustment is estimated at $1,180,000. Using that estimate would result in estimated gift, estate and GST exemptions of $11,180,000 for 2018.

Under the Act, however, the increased exemption amounts sunset beginning on January 1, 2026.

What does this mean for your estate plan?

Because of the increased exemptions and the sunset provisions, it is especially important that clients review their current estate plan documents with legal counsel.

Of special importance is a review of the funding formulas that determine the dollar amount of bequests and trust shares to ensure that they work both before and after the sunset and to be sure that clients are comfortable with the amounts passing either outright or in trust for the benefit of a spouse, children and other beneficiaries.

Is a funded revocable trust still a good idea?

Most clients use revocable living trusts to avoid probate of their assets, provide for privacy upon their death and to minimize federal and state estate taxes. This continues to be the case even after the new Act.

Another benefit of using revocable trusts to continue to hold assets in trust is to provide for protection of the trust assets for a surviving spouse and children. This protection is not just from estate tax but also from business creditors and potential divorcing spouses. This is another important reason to continue to use trusts.

What are the income tax implications?

The Act, in increasing the available gift, estate and GST exemptions, also has the effect of making income tax planning even more important.

Under the Act, at the death of the first spouse there is still a step-up in income tax basis for the value of all assets (other than retirement plans) owned at death to fair market value as of date of death. The purpose of this is to avoid double taxation, i.e., both an estate tax and an income tax.

The step-up in income tax basis applies whether or not there is any estate tax due. For example, for a married couple when the first spouse dies, assets in that spouse’s name and one-half of the joint assets will receive a step-up in basis for income tax purposes. If those assets are held in a trust for the surviving spouse, a so-called credit shelter trust, which will not be subject to estate tax in the surviving spouse’s death, those assets will not receive an income tax step-up at the death of the surviving spouse.

Clients will want to be sure that there is flexibility in their trust document to allow an independent trustee or a trust protector to grant a general testamentary power of appointment to a surviving spouse for part or all of the assets in trust so that those assets can receive a step-up in income tax basis, should appreciation of those assets be significant.

Can unused exemption still be transferred to a surviving spouse?

Under the Act, the concept of portability still applies. This means for a married couple if a spouse dies without using all of his or her available federal estate tax exemption, it will “port” or transfer to the surviving spouse.

It is necessary, however, to file an estate tax return to claim portability and there are technical rules that apply should a spouse get remarried.