Increased Federal Basic Exclusion Amount
There is good news for many taxpayers at the Federal level: the “Tax Cuts and Jobs Act,” P.L. No. 115-97, increases the Basic Exclusion Amount for estates of decedents dying on or after January 1st, 2018, to $10 million. When the inflation adjustment is added in, the effective Exclusion Amount becomes nearly $11.2 million. As a result, married persons may transfer up to $22.4 million via lifetime gifts or testamentary transfers, or a combination of the two, estate and gift tax free. Clearly, this presents an enormous wealth transfer opportunity, provided certain steps are undertaken to guarantee the benefit, as described below.
Thus, for example, if a predeceased spouse’s estate is valued at less than the Basic Exclusion Amount, his or her personal representative may elect “portability,” which permits the surviving spouse or his or her estate to utilize the predeceased spouse’s unused Exclusion Amount, provided a portability election is made on a timely filed Federal Estate Tax Return.
The portability election must be made, whether or not the estate is subject to the Federal Estate Tax. Therein lurks a trap for the unwary for estate planners: if the personal representative of the predeceased spouse’s estate fails for any reason to make the election, portability will be sacrificed. This scenario occurs more frequently than one might expect in second marriage situations, where the predeceased spouse has children from a prior marriage, relations between the surviving spouse and these children are strained and the surviving spouse is appointed personal representative of the predeceased spouse’s estate. Consequently, the personal representative must be chosen with great care. One way to accomplish this would be to appoint the surviving spouse and a trusted third party as co-personal representatives and to confer upon the third party the exclusive power to elect portability.
As mentioned above, under the current Federal Estate Tax regime the Applicable Exclusion Amount applies equally to lifetime and date of death transfers, so it is possible to allocate the Exclusion Amount to either or both, as circumstances dictate. Fearing a later reduction in the Act’s generous exclusion amount, commentators are already suggesting that taxpayers should begin to make lifetime gifts without delay. If such gifts are made using “freezing” techniques such as Grantor Retained Annuity Trusts and Qualified Personal Residence Trusts, the tax reduction effects of inter vivos gifts can be leveraged substantially.
Basis Consistency Rules
Left undisturbed by the Act is the basis step-up rule, which accords to all assets included in the decedent’s gross estate a step-up in their tax basis to their date of death value. (Compare this to the “carryover basis” rule that applies to lifetime gifts). This, too, presents an enormous tax planning opportunity; if high basis assets are gifted and highly appreciated assets are retained until death, their subsequent sale will generate little or no income tax. Asset selection is, therefore, critically important when gifts are contemplated, particularly as the Basic Exclusion Amount continues to rise and the focus of planning has shifted from estate and gift taxes to income taxes.
On the subject, practitioners should be aware of the “Basis Consistency Rules” introduced in 2015 and interpreted by Proposed Regulations issued on March 2, 2016. Pursuant to the rules, certain estates are required to report to the IRS and disclose to the recipients of the estate’s property, the date of death (or alternate valuation date) values of a decedent’s assets. The regulations further require that there be consistent basis reporting between the estate and the beneficiary receiving the property. This is a significant departure from previous practice, where a beneficiary was at liberty to report on his or her income tax return whatever basis he or she independently determined for the property.
The Basis Consistency Rules apply only to estates that are required to file a Federal Estate Tax Return which, under current law, means persons whose gross estate exceeds the Applicable Exclusion Amount, or $11.2 million in most cases. The proposed regulations clarify that those estates filing a return solely for purposes of electing portability, so-called “portability returns,” are exempt from the rules, so only the largest estates will be affected. Filing is accomplished by completing Form 8971 and filing it with the IRS and providing each beneficiary with a copy of Schedule A of the form. The penalties for noncompliance are severe, so personal representatives should familiarize themselves with the complexities of the rules, especially the filing deadlines.
Increased Annual Exclusion Amount
Finally, there is yet another planning opportunity enhancement resulting from the increase of the “Annual Exclusion Amount” from $14,000 in 2017 to $15,000 in 2018. As a result, the value of assets that may be gifted to individuals (without limit as to their number) transfer tax free has increased. And, if the gifts are made pursuant to a discounting technique involving the use of Family Limited Partnership or LLC interests, as an example, the leverage can be substantial.
Conclusion
While some clients may feel that there is no further need for estate planning, such a view is shortsighted, since there is no guarantee that future Federal estate and gift tax legislation will preserve the current generous exemptions or that the New Jersey estate tax repeal will be permanent. For that reason alone, a flexible estate planning document, such as a Disclaimer Will with Bypass Trust, should still be considered as part of the estate planner’s arsenal.
As well, a carefully crafted estate plan will still be required for nontax reasons in specific circumstances, such as second marriages with children of the previous marriage; where beneficiaries have special needs; where elderly persons wish to plan for Medicaid eligibility; where a charitably inclined client wishes to obtain the transfer and income tax advantages presented by use of a Charitable Lead Trust; where creditor protection is desired; and where the prospective surviving spouse is not a US citizen, to name but a few examples.
As can be seen, enhanced planning opportunities await those who act in timely fashion.