How Does the New Tax Law Affect Your Estate Plan?

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How Does the New Tax Law Affect Your Estate Plan?

President Donald Trump signed a new tax plan into law in December 2017. The change, formerly known as the “Tax Cuts and Jobs Act,” will have far-reaching implications in many areas of tax and financial planning. Estate planning is one key area of effect.

Changes Under the Tax Reform

The estate tax exemption has been increased to $11.18 million per individual and $22.36 million per married couple for 2018. That was a major increase above previous restrictions. According to the IRS, an individual’s estate tax exemption is $11.7 million in 2021 and $12.06 million in 2022. This removes any federal estate taxes on sums less than specified limitations that are given to heirs during your lifetime or bequeathed to them after your death.

Except for the richest people, the new law virtually removes the federal estate tax. One caveat: these restrictions, like the majority of the act’s provisions, are due to expire at the end of 2025. The exemption amounts will then return to former levels, adjusted for inflation.

Generation-Skipping Tax

Individuals and married couples now get the same level of exemption from the generation-skipping tax (GST) as before. This increment will similarly be phased off by the end of 2025.

Finally, the technique for computing inflation on these exclusions and other relevant areas has been altered. Inflation and exemptions will now be computed using the Chained-CPI, a modified measure of inflation that compensates for “situation bias,” or evolving consumer buying patterns, rather than the regular Consumer Price Index, which was previously utilized. In general, the Chained-CPI gives a lower rate of inflation.

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What This Means for You

Because of the temporary increase in the exemptions for the federal estate tax and the GST, many people will be able to leave more of their assets to their heirs without paying estate taxes until the end of 2025 (unless Congress repeals or extends these laws). The new legislation has clear advantages for beneficiaries, but its implementation does not remove the need for estate and tax preparation.

Consider These Issues

The most recent tax reform does not eliminate the estate tax in states that have one. If you reside in one of the states listed below, your assets will be liable to the applicable amount of any state-imposed estate tax:

  • Connecticut
  • District of Columbia
  • Hawaii
  • Illinois
  • Maine
  • Maryland
  • Massachusetts
  • Minnesota
  • New York
  • Oregon
  • Rhode Island
  • Vermont
  • Washington

Furthermore, with many states having significant economic issues, it’s not out of the question that other states that don’t already have an inheritance tax would contemplate introducing one in the future.

Individuals facing state-level estate taxes can consider using a disclaimer and a bypass trust, or a qualified terminable interest property (QTIP) trust, to reduce the effect of taxes on their estate.

With the expanded exemption levels, lifelong donations of estate assets may be made without fear of triggering federal gift and estate taxes, unless the estate exceeds the exemption thresholds. Gifting may also be done with the intention of transferring assets that are likely to be highly appreciated. This may protect the gain in those assets from future inheritance taxes in your estate when the present exemption limitations expire in 2025.

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It’s important to note that unlike assets handed to heirs upon your death, lifetime gifts do not qualify for a step-up in cost basis. This implies that before donating valued assets such as stock, evaluate the tax implications for the receiver.

A Strategy to Protect a Spouse

The spouse lifetime access trust is one strategy to explore in certain instances (SLAT).The SLAT is an irrevocable trust that transfers assets from an individual’s estate to an irrevocable trust for the benefit of their spouse. The advantage is that those assets are removed from the individual’s estate, enabling them to take advantage of the greater estate tax exemption before the 2025 deadline while still keeping some control over those assets via their spouse throughout their lifetime.

SLATs do have drawbacks. If the couple divorces, the grantee has no claim to the SLAT assets. It is also crucial to ensure that the trusts are not similar if both spouses utilize a SLAT. This reduces the possibility that the trusts may be regarded substantially similar, in violation of the “reciprocal trust doctrine,” which might lead to the trust’s invalidation.

Accidental Disinheritance

One unexpected effect of greater exemption limitations is that some heirs may be disinherited accidentally. Many estate plans include a bypass trust, which orders a trustee to finance the bypass trust with any outstanding estate tax exemption amount. This would be done prior to transferring the estate’s remaining assets to the designated heirs.

Because of the magnitude of the bypass trust in this situation, some heirs may be unwittingly disinherited. Those who have this sort of provision in their will should evaluate their estate planning paperwork.

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The Life Insurance Option

Life insurance policies have long been used to assist heirs in covering any estate taxes that may be owed owing to a big inheritance that exceeds the exemption limitations. The incidence of these exemptions may decrease as the exemption increases.

These policies may now act as a safety net for the estate, enabling grantors to convey assets in a tax-efficient way and providing liquidity in circumstances when certain estate assets, such as real estate or a business investment, are illiquid.

The Bottom Line

Beginning with the 2018 tax season, tax reform has resulted in several changes for taxpayers. Estate planning is one area that has been touched, although the effect, like much of the tax reform legislation, is transitory and will mostly return to earlier laws after 2025.

It is especially important for people with bigger estates to evaluate their present estate planning arrangements to verify that they still do what you planned and that they take full advantage of any possibilities provided by tax reform.

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