Slightly Withered Estate Exemption Amount Released, But Estate Planning Remains an Evergreen Opportunity

Susan P. Rounds, JD, CPA, LL.M. (taxation), AEP®, TEP

The 2018 Inflation-Adjusted Estate, Gift and GST Exemption is $11.18 individual / $22.36 married with portability.

The Tax Cuts and Jobs Act doubled the estate exemption amount to $10 million per individual / $20 million per married couple. This doubled exemption amount is set to expire at the end of 2025 and, unless Congress intervenes, will revert back to where it was prior to the 2017 Act ($5 million individual/ $10 million married with portability). As you know, the basic estate exemption amount is adjusted annually for inflation.

The 2018 inflation-adjusted figures were finalized on March 5th resulting in $11.18 million individual/$22.36 million married with portability. The previously seen amounts of $22.2 million per individual/ $22.4 million married have been adjusted slightly downward due to the newly adopted “chained CPI” method of calculating inflation, which is now required under the new tax act. (Note that the 2018 annual gift tax exclusion amount of $15,000 individual/ $30,000 with spouse previously released by the IRS in Nov 2017 stands.)

Why It Matters: The doubled exemption amount creates an unprecedented lifetime gifting opportunity but may also derail previously drafted estate plans.

THE GOOD: Gifting the exemption amount during life can be tax efficient because all appreciation in the gifted assets occurs outside the estate of the grantor. Moreover, when assets are gifted to a trust sitused in a state that has abolished or extended its rule against perpetuities, such as Delaware, South Dakota, Nevada, or Alaska among others, the assets and corresponding appreciation could potentially be transferred across multiple generations sheltering enormous wealth from additional exposure to the estate or generation skipping tax (among other benefits).

THE BAD: On the flip side, because many estate planning documents are drafted so that a bequest to a certain trust is dependent on the amount of the federal exemption, either too much or too little may end up passing to the spouse or to the children. Two recent examples of static documents interpreted in light of changing tax law involved trust language that directs distribution of the maximum amount that can be “passed free of the federal estate tax” to the children’s trust first, with the remainder of the estate going to the surviving spouse.

• In one situation, the parents are adamant that “the children are already provided for” and do not want additional money going to them. Instead, the children’s trust is on course to receive $11.18 million with inflation adjusted increases each year at the death of the first spouse. The marital trust for the surviving spouse will get what is left over. Both spouse’s documents read the same, so upon the death of the second spouse the kids could ultimately get the benefit of $22.36 million plus inflation adjustments.
• In another situation, not only will $11.18 million go to the children’s trust upon the death of the first spouse, but it will then be distributed outright to the children at the death of the surviving spouse. The client has already stated a concern about how much the adult children will have direct access to and when. The spouse’s documents mirror this language, so at the second death, the kids would receive $22.36 million outright.

THE UGLY: The provision doubling the exemption amount sunsets at the end of 2025 under current law. What happens if a client gifts the full doubled exemption amount during life and then the exemption reverts back to the 2017 amount? Perhaps a client then dies in 2026—would the estate be liable for a 40% federal estate tax on the previous gift amount in excess of the now reduced exemption? This would be what is referred to as a “clawback” and in this example the tax could be $2 million or more. Many estate planning practitioners believe that a potential clawback is not what Congress intended and we are awaiting regulations from the Treasury that will address what will happen if there is a difference in the exemption amount at time of death.

These are just conversation appetizers for estate planning advisors. There is an array of options to be explored with clients, including perennial staples such as leveraging gift opportunities by transferring assets that can be discounted; transferring assets via note sale to a specially drafted trust; using the annual exclusion to purchase life insurance inside a trust to create liquidity or as a wealth replacement mechanism; incorporating charitable planning to enhance income tax and gift tax efficiencies; plus, business succession planning, etc.

Happy Reading!
“Knowledge is weightless, a treasure you can carry easily” – Anonymous

Email me at editor@naepcjournal.org with your opinions and suggestions.

---

This information is provided for discussion purposes only and is not to be construed as providing legal, tax, investment or financial planning advice. Please consult all appropriate advisors prior to undertaking any of the strategies outlined in this article, many of which may involve complex legal, tax, investment and financial issues. This communication is not a Covered Opinion as defined by Circular 230 and is limited to the Federal tax issues addressed herein. Additional issues may exist that affect the Federal tax treatment of the transaction. The communication was not intended or written to be used, and cannot be used, or relied on, by the taxpayer, to avoid Federal tax penalties. MRG026830