2017 Tax Law: Estate and Gift Tax Changes
On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law by President Trump. All partners, attorneys, and staff members at MendenFreiman stand ready to consult with you on how this sweeping reform impacts your unique situation. Important tax planning and non-tax planning considerations that could impact your estate and gift taxes are:
Tax planning considerations. The TCJA greatly reduces the number of estates that will be subject to federal estate and gift taxes (until December 31, 2025). With the step-up in tax basis retained and a much higher federal estate tax exemption, income tax planning becomes a much more important element in estate planning and estate administration. For estates impacted by the sunset of the doubled exemption at the end of 2025 (or sooner if tax laws are changed by a new administration or Congress), this will be further complicated by a potential “use-it-or-lose-it” scenario. Each case is unique and there are a number of planning options that can be utilized to accomplish the specific goals of an individual client, including the following:
- Irrevocable Life Insurance Trusts (“ILITs”): Life insurance can be used to provide income for a family, pay estate taxes, and as an income tax shelter. If structured properly so the trust maker (grantor) does not have any incidents of ownership, none of the assets (policy proceeds) of an ILIT will be included in the grantor’s taxable estate, making them free of both income and estate taxes. The general concept is that the ILIT is the owner and beneficiary of the policy on the grantor’s life. The grantor makes gifts to the trust to cover the insurance premiums, and the trustee makes the premium payments. At the grantor’s death, the proceeds are paid to the trustee who can use the funds to purchase assets from the estate and provide liquidity for estate taxes and other expenses. The trustee can make discretionary distributions of income and principal during the lifetime of the trust’s beneficiaries, which can include the grantor’s spouse, children, and future generations. Assets that remain in the trust are not included in the beneficiaries’ estates and are protected from creditors.
- Dynasty Trusts: Generally, a dynasty trust is one that benefits multiple generations, and none of the trust assets are included in the grantor’s or any of the beneficiaries’ taxable estates. Avoiding estate taxes at each generation allows the assets to be preserved far longer than they would otherwise be. The dynasty trust established in the right jurisdiction can theoretically go on forever, with the trustee making discretionary distributions for the lifetime of each beneficiary in each generation. Advantages include creditor protection, divorce protection, estate tax protection, direct descendent protection, spendthrift protection and consolidation of capital, which typically results in higher returns and better management options.
- Grantor Retained Annuity Trusts (GRATs): The creator of a GRAT retains an annuity payout from the trust for a fixed term. At the end of the annuity term, any residual assets remaining in the trust pass to the remainder beneficiaries (such as the trust creator’s children) free of any gift and estate tax — but not free of GST tax exposure. The tax treatment of a GRAT is based on the assumption that the GRAT assets will grow at the Section 7520 rate in effect at the time the GRAT was established (2.6% in January 2018). If the GRAT assets outperform the 7520 rate, there will be a larger-than-anticipated (for tax purposes) balance to transfer to the trust’s remainder beneficiaries at the end of the annuity term. In addition, all income earned by the GRAT during its term is taxed to the trust’s creator because the trust is “defective” for income tax purposes, allowing for an enhanced probability of having a tax-free gift to the remainder beneficiaries.
- Intentionally Defective Grantor Trusts (IDGTs): An IDGT is a trust that is a grantor trust for income tax purposes but not for gift, estate, and GST tax purposes. IDGTs are especially powerful for clients who may be subject to the estate tax (before or after the 2025 sunset) because of the historically low interest rates. Techniques include gifting or selling (or both) undivided interests in assets to these trusts at values that can be discounted due to minority interest. If the assets are wrapped in an LLC or limited partnership, their value may also be adjusted for lack of marketability and lack of control. If sold, the trust then pays an installment note back to the grantor of the trust. Assuming the growth rate on the assets sold to the IDGT is higher than the interest rate on the installment note, the difference is passed on to the trust beneficiaries free of any gift, estate and/or GST tax. Also, because the IDGT is a grantor trust (i.e., “defective” trust for income tax purposes), no capital gains tax is due on the installment sale, the interest income on the installment note is not taxable to the grantor, and all income earned by the trust is taxed to the grantor, effectively allowing for a tax-free gift to the trust’s beneficiaries equal to the tax burden borne by the grantor. Discretionary distributions of income and principal are made to the trust beneficiaries during their lifetimes, and all assets in the IDGT remain outside of their taxable estates.
Non-tax planning considerations. The estate tax has always been and will continue to be a secondary motivation for estate planning. The maxim, “don’t let the tax tail wag the planning dog” is just as true under the TCJA as it has always been. Proper planning is motivated by a desire to preserve, protect, and transfer assets; and estate tax considerations are just one aspect of that. As always, the primary considerations for estate planning remain the same:
- Disposition of Property: Many people do not realize that if they die without a will, state intestacy laws will govern the division and distribution of their property. For example, in Georgia, if someone dies without a will and is survived by a spouse and children, the spouse and children must split the property. The amount the surviving spouse will receive is dependent on the number of surviving children. Also, if the surviving children are minors, the surviving spouse will be required to file annual accounting reports to the Probate Court for all the minors’ inheritances until the minors reach the age of majority. Georgia does not recognize common-law marriage; therefore, an unmarried surviving partner will not receive any of the decedent’s property under Georgia’s intestacy laws.
- Designation of Guardians and Conservators for Minor Children: Under Georgia law, testamentary designations control the appointment of both guardians and conservators. Without a will, Georgia law provides that any “interested person” may petition for the appointment as a guardian of a minor (subject to certain preferences) and further subject to court determination of the minor’s best interests.
- Creditor/Divorce Protection: Trusts can provide creditor protection to the trust beneficiaries whereas outright bequests or gifts received by adult beneficiaries under state law will be exposed to the beneficiaries’ creditors. Similarly, assets held in trust for a child do not become a part of that child’s marital property and are not subject to forfeiture in case of divorce. In addition, such trusts can dictate at what age the beneficiaries can receive the property outright, what the money held in trust can be used for in supporting the beneficiary, and who will be in charge of those decisions.
- Incapacity Planning: Planning for incapacity has become an increasingly important planning topic since longer life expectancies make physical or mental incapacity more likely. If there is no designated financial or health care agent in place, it may be necessary to petition the court to appoint a guardian or conservator, resulting in unnecessary delays and additional costs. In the absence of a health care agent, Georgia law designates who may authorize surgical or medical treatment. However, the designation may not cover all health issues and may not be the person the individual would want to make those decisions. In management of finances, one method of achieving a seamless transition in the case of an incapacitated client is through the use of revocable trusts. Additionally, financial powers of attorney can be used, even though they have a history of difficulty in getting third parties to recognize their validity. Fortunately, Georgia has recently updated its law to ensure that banks and other institutions will respect powers of attorney that meet the requirements of the new law.
MendenFreiman’s TCJA Consultation. We understand this new law is a lot to digest, and we want to ensure that our recommendations match your individual estate and gift plans. If you would like more details about any aspect of how the new law may affect you, please do not hesitate to contact us to schedule your consultation session.