The biggest change in 2018 to the Trusts & Estate law is the ballooning estate tax exemption. From 2017 to 2018 the exemption doubled from $5.45 Million to $11.2 Million per person. In addition, over the next years the exemption will continue to climb based on the rate of inflation. The lifetime gift tax was retained, with the same lifetime exemption as the estate tax. The carry-over basis for gifted assets AND the step-up in basis for inherited assets was also retained. But beware, there is a sunset provision scheduled for the year 2026 – which means that in year 2026 the exemptions are scheduled to revert back to the 2017 levels.
What does this mean for planning in general? Although it is hard to predict what Congress will do in the future, the 2026 “reversion” is extremely problematic in the estate and gift area. Other taxes, like income tax, operate on a year-by-year basis. Accordingly, it is possible to raise and lower income tax rates because each year stands on its own – the taxes you owe in one year are not related to the taxes you owe in any other year. The estate and gift tax are different. Because it is a cumulative calculation, it’s difficult, and maybe unfair, to reduce an exemption once that exemption is in place – people who make lifetime gifts before they die AND before the “reversion” would have the benefit of a higher exemption (they would have given away a large amount tax free), and they would have it for the rest of their lives (in the case of gift tax). Those who do not make lifetime gifts will be subject to the exemption as it exists upon their death. As such, planning for larger estates is very tricky in this time of great flux. It would be much fairer in 2026 to simply retain whatever exemption is in place at that time. But 2026 is eight years away.
Now there are several consistent themes applicable to estate planning:
For the vast majority of people, Federal Estate or gift tax is now something that only applies to someone else. And, for a couple, with a combined exemption of $22.4 million, the first $22.4 million passes free of tax and estates up to $44.8 million will face an effective tax rate of 20%, with a step up in basis for capital gains purposes. The Federal Estate and gift tax is now at one of the lowest rates of all the various Federal and State taxes.
California has no estate tax.
For many years (really decades) the incentive was to make gifts of assets likely to appreciate so that the appreciation was realized at a younger generation. Now, the basic incentive is to hold onto appreciated property so that when the owner dies the beneficiaries will receive the property with a step-up in basis. Then, the beneficiary can sell the asset and potentially not pay any tax. In California the combined Federal and State Rate for capital gains exceeds 30%.
With $22.4 million per couple, the step-up in basis is a significant benefit which results in millions of dollars of savings on capital gains as long as the older generation dies with the appreciated property.
And now, there is even more incentive to make lifetime gifts of cash (because the increased exemption allows for them) and retain property that is appreciating (so that the appreciated property gets the step up in basis at death.
Overall, there has now been a shift in the structure of revocable trusts for a couple. The enactment of portability and the now high exemption means that leaving everything to the surviving spouse is now not a “dangerous” lack of tax planning – compared to the days of lower exemptions, where failure to set up a Bypass trust meant a huge potential increase in tax liability.
However, the tax concerns have been replaced by practical concerns related to (1) the increase in blended second marriages (which carries with it the risk that the children of the respective spouse will not get along), and (2) the risk of the surviving spouse remarrying (which is an obvious risk for the children from the first marriage). These two risks may nullify any gain in simplicity caused by the change in the law.
So, for many people, the classic trust structure which sets up an irrevocable trust on the first death remains the preferred plan.