The Tax Cuts and Jobs Act of 2017 (referred to as “TCJA”), which became effective on January 1, 2018, makes several changes to federal tax law that will have a significant effect on estate planning over the next several years. The following discussion presents the highlights of these changes, and the planning opportunities they present.
Temporary Increase in Federal Estate and Gift Tax Shelter Amount
Prior to TCJA, the amount that an individual could shelter from federal estate and gift taxes was scheduled to be $5.6 million for 2018. TCJA effectively doubles that amount, so that for lifetime gifts and death-time transfers occurring in 2018, the amount that can be protected is $11.2 million per individual (or for a married couple, a combined $22.4 million). This increased shelter amount is due to continue until December 31, 2025.
On January 1, 2026 the shelter amount will revert back to $5.6 million, perhaps with some allowance for inflation that may have occurred in the intervening years.
Planning Strategies Based on $11.2 Million Shelter Amount
Given the last-minute and frankly partisan manner in which the TCJA was passed, there is a risk that the $11.2 million per person shelter amount may not remain in effect until 2026. A return to a $5.6 shelter amount (as adjusted for inflation) may occur well before that time. Thus, individuals and couples with significant wealth should consider taking steps in 2018 that will take advantage of the increased shelter amount, since it provides a limited-time opportunity to transfer significant assets tax-free to children and grandchildren, or to trusts for their benefit.
Planning strategies that will take advantage of the increased shelter amount include:
- Making gifts of interests in a limited liability company or family limited partnership to children and grandchildren, or trusts for their benefit.
- Generally, no gift tax will actually be payable as long as a donor’s total lifetime taxable gifts do not exceed $11.2 million.
- Using life insurance trusts to hold policies on a senior family member, which will allow the gifts of premium dollars to be leveraged when compared to the ultimate amount of policy proceeds.
- Creating grantor retained-interest trusts, and grantor annuity or income trusts that will permit the transfer of assets for the benefit of children and grandchildren to be taxed at a lower valuation than the assets’ actual fair market value.
Opportunity to Simplify Wills and Trusts
In years past when the shelter amount was much lower, many married couples were advised to create wills containing a credit shelter trust for the surviving spouse, the sole purpose of which was to reduce federal estate taxes. Now that the shelter amount has risen to $11.2 million (or in all events $5.6 million), the need for such credit shelter trusts has been eliminated for most couples.
Thus, this may be the perfect time for couples who have not updated their wills in several years to revise their estate plans to eliminate trusts and other limitations on the surviving spouse that based solely on federal estate taxes. (Of course, there may be good reasons, such as dementia or Medicaid qualification, where a trust for a spouse would continue to be indicated.)
Note on Pennsylvania Inheritance Tax
The TCJA’s changes to federal gift and estate tax law do not affect the Pennsylvania inheritance tax, which will continue to be imposed on transfers of taxable property at death and to lifetime gifts in excess of $3,000 per donee occurring within one year of death. Unlike the federal estate tax, there is no minimum shelter amount applicable to the Pennsylvania inheritance tax.
2018 Federal Gift Tax Annual Exclusion Amount Increased to $15,000
Federal law allows donors to exclude a certain amount of their gifts made each year to any number of donees, without having to use their $11.2 million shelter amount. This annual exclusion amount had been $14,000 for the past several years. While technically not part of TCJA, the 2018 annual exclusion amount has been increased to $15,000 per donee. Spouses can together make gifts of up to $30,000 per donee without using their combined shelter amount. If an annual gift-giving program is employed over several years, a significant amount of wealth can be transferred tax-free.
Income Taxes on Trusts and Estates
For 2018, the federal income tax rate applicable to estates and non-grantor trusts is 37% of ordinary income in excess of $12,500. As with individuals, this rate does not include the additional 3.8% net investment income tax on passive income.
The federal income tax brackets for non-grantor trusts and estates are extremely compressed as compared to those of individuals. For example, while the maximum 37% tax rate is imposed on estate and trust income in excess of only $12,500, that same 37% rate is not imposed on an individual until their income reaches $500,000, and $600,000 for married couples.
Unfavorable Change to the “Kiddie Tax”
Gifts to minor children of income-producing property, such as interests in a family limited partnership or investment assets held in a PUTMA account, can spread the senior family members’ income among lower-bracket family members. However, perceiving this as an abuse, Congress has long imposed a “kiddie tax” that is meant to limit the benefit of this technique. Under pre-2018 law, the unearned income of a child under age 19 and a college student under age 24 was taxed at their parents’ tax rate, if the parents’ tax rate was higher than that of the child, thus negating the tax savings that could result from use of a lower tax bracket.
The TCJA treats the “kiddie tax” even more unfavorably by taxing the net unearned income of covered children at the rates applicable to trusts and estates, rather than those of the parents. For parents who are not in the highest tax bracket, this change will cause the child’s unearned income over $12,500 to be taxed at 37%, a rate that is higher than the rate of the parents. This change clearly goes well beyond the underlying purpose of the “kiddie tax.”
529 Plans Extended to Elementary and Secondary School Tuition
Under pre-2018 law, the use of a 529 Account was limited to paying for the expenses of higher education at an “eligible educational institution” that was registered with the U.S. Department of Education. The TCJA has expanded this rule to permit distributions from a 529 Account to pay for a student’s tuition at an “elementary or secondary public, private, or religious school.” However, such distributions are limited to $10,000 per student per year. For more information on 529 Plans, see our separate article on the topic.
Cash Contributions to Charities
For taxpayers who itemize deductions on their Form 1040, a deduction can be claimed for charitable donations of cash or other assets. The amount of the deduction that can be taken in any one year is limited to a certain percentage of the taxpayer’s adjusted gross income (“AGI”). Under pre-2018 law, the deduction limit for cash contributions was 50% of AGI.
For 2018 the TCJA increases to 60% of AGI the deduction for cash contributions made to public charities, private operating foundations, and certain private foundations with sufficient qualifying distributions. For all other private foundations, the limitation is 30% of AGI for cash contributions. The deduction for non-cash distributions has not been changed.
Changes to Standard Deduction May Adversely Affect Charitable Giving
Notwithstanding the increased deduction for cash gifts, overall the TCJA may cause a significant drop-off in charitable giving. TCJA increases the standard deduction to $12,000 for single individual taxpayers and $24,000 for married couples, which will eliminate the ability (and need) of many taxpayers to itemize their deductions, including charitable gifts. In addition, these higher thresholds will be more difficult to reach, since TCJA has limited or eliminated several other itemized deductions.
– Martin J. Hagan
For more information about this or any private client matter, please contact Dan Gallagher, Martin Hagan, or any of the MUS Private Clients Group attorneys with whom you may have worked.
This material is for informational purposes only. It is not and should not be solely relied on as legal advice in dealing with any specific situation.