Tax Cuts and Jobs Act of 2017

Late last year, Congress passed and the President signed new tax legislation known as the Tax Cuts and Jobs Act of 2017 (TCJA), that was generally effective January 1, 2018. While the legislation was not the tax simplification or tax reform that many would have liked, it is hopefully a move in the right direction. Given its passage late in the year, it has wreaked havoc for tax practitioners trying to determine the effect moving from 2017 to 2018. Individual and corporate income tax rates have been reduced, several business deductions and credits have been eliminated or reduced and other tax breaks have been enhanced. It is primarily an income tax act and it did not repeal the Federal estate and gift tax, which had originally been discussed.

Estate and Gift Taxes. From an estate and gift tax planning standpoint, the Tax Cuts and Jobs Act of 2017 doubled the combined estate and gift tax exemption amounts and the generation-skipping transfer tax (“GST”) exemption amount, thus having an impact on the high net worth estates. Theoretically, the actual increases of the exemption amounts are only temporary inasmuch as, if Congress does not act again by 2026, the exemption amounts will revert to the 2017 levels, which were approximately $5,500,000 for single taxpayers and approximately $11,000,000 for married couples with proper estate tax planning. In the history of the estate and gift tax legislation, the exemption amounts have never decreased; however, the possibility exists that reductions may occur in 2026.

From an estate and gift tax standpoint, with respect to people dying or gifts made after 2017, but before 2026, the estate and gift tax and GST tax exemption amounts will increase to approximately $11,200,000 and $22,400,000 (for married couples). Such amounts will be adjusted for inflation in future years. The marginal estate, gift and GST tax rates will remain at 40%.

To put this in perspective, approximately 0.4% of taxpayers were subject to the old $5,500,000 estate tax exemption equivalent amount. In other words, only four out of every 1,000 people were subject to it. Now, that number has been reduced further. At first glance, the thought might be that there is no longer a need for tax motivated estate planning because of the increased estate exemption equivalent amounts and the fact that the estate tax will apply to a very limited number of people.

Lifetime Gifts. Given the very high exemption amounts applying for estate, gift and GST tax purposes and further given the possibility that these amounts could be reduced later, there are currently tremendous opportunities available to make very significant lifetime gifts, which gifts, and the future appreciation thereof, would permanently avoid transfer taxes in the future, even if smaller exemption amounts are reinstated at some point in the future. The disadvantage of lifetime gifts has always been the lack of a step up in income tax basis, that otherwise applies if an asset is owned at the time of a person’s death. The step up in basis serves to reduce the capital gains tax on any appreciation in that asset prior to the person’s death. Accordingly, income and capital gains taxes could be increased as a result of any gain ultimately realized by the recipients of those gifted assets. The transfer tax savings must be weighed against any additional income and capital gains taxes.

Section 529 Plans. The benefits of the Section 529 College Savings Plans have also been permanently expanded. Such plans permit tax free withdrawals for qualified educational expenses, now including elementary and secondary school expenses, and contributions to such accounts can be removed from a person’s estate, even if that person retains the ability to change beneficiaries or get their money back. A primary benefit of Section 529 Plans isthat five years’ worth of gift tax annual exclusions can be bunched into a single year without triggering any gift taxes or GST taxes or using any amount of exemption amounts. For example, given the current annual exclusion of $15,000, a person could contribute $75,000 (or $150,000 for married couples) without having any transfer tax effect.

Dynasty Trusts. Given the substantial amounts that can be transferred now, now may be an appropriate time to establish a Dynasty Trust that allows substantial amounts of wealth to grow and compound free of any transfer taxes for your grandchildren and any future generations. The GST tax, which is also calculated at the 40% rate, was originally designed to tax transfers to grandchildren and others that skip a generation. By leveraging the now greatly increased GST tax exemption amount, even greater amounts can be transferred to your grandchildren and future generations. A transfer of $11,200,000 to a properly structured Dynasty Trust will not be subject to gift tax because it is within the available gift tax exemption amount and such assets, together with all future appreciation, will be removed from your taxable estate. Further, by allocating the GST tax exemption to the contribution to the Dynasty Trust, any future distributions or other transfers will avoid GST taxes, regardless of the value of the assets and the exemption amounts in the future.

So, in the final analysis, while the Tax Cuts and Jobs Act of 2017 was primarily an income tax act, it does have an impact on your estate planning and is all the more reason for you to take advantage of the opportunities that are presented by speaking with your legal, accounting and financial advisors.