While much of year-end planning is focused on income tax, individuals and their tax advisors also should consider the opportunities that exist for year-end transactions. While a longer-term benefit awaits, missing an opportunity could result in additional transfer tax at a later date. Particularly with the recent tax law changes, taking a fresh look at your estate and gift objectives is important.
Let’s start with a quick overview of the transfer tax system and a review of the current amounts. In 2018, each individual can transfer a cumulative $11,180,000 during either lifetime or death without incurring a transfer tax (gift tax during life or estate tax at death). This amount is adjusted for inflation annually and is significantly larger than prior years due to changes included in the Tax Cuts and Jobs Act (TCJA) in late December 2017, effective for transfers made on or after January 1, 2018, and before January 1, 2026. This doubled lifetime amount is scheduled to revert back to an inflation-adjusted $5 million per person in 2026 absent further legislative action. In addition, each year every individual has an annual exclusion—$15,000 in 2018—that can be used to make current transfers of wealth to anyone without using part of their $11,180,000 lifetime exemption amount.
Since the annual exclusion of $15,000—up from $14,000 in prior years—is available each year, it’s wise to make sure you’re taking advantage of these transfers before the end of the year. A married couple can double this amount and transfer up to $30,000 by electing to gift-split so both exclusions are available. If the gift is made in trust, you’ll need to make sure the trust is structured so the gift is considered a gift of a present interest and so the trustee provides the proper notification to the beneficiary in what’s often referred to as a Crummey letter.
Although not new, as you look toward using gifts that don’t affect your available exclusions, you should consider paying educational and medical costs for your family. The payment of tuition directly to the institution for the benefit of your grandchildren, however, doesn’t count toward the available annual exclusion. Similarly, medical costs paid directly to the provider aren’t considered when looking to potentially taxable transfers made.
Given the increased lifetime exemption and annual gift exclusion amounts, there’s a unique and limited opportunity until the end of 2025 for a couple to transfer significant wealth during their lifetime without incurring a transfer tax. Taxpayers who previously made transfers that fully used their available exemption have a “new exemption,” for a limited period, to make larger gifts to further reduce their estates—subject to estate tax—at their deaths. As mentioned above, reviewing your overall estate plan at this time is important. The structure you had in place for a larger exemption may need to be modified to accomplish the desired results after the TCJA. In addition, the income tax issues should be considered when transferring significant wealth during lifetime. Unlike assets that pass to beneficiaries at your death and receive a new income tax basis equal to the fair market value of those assets at your date of death, i.e., the “step-up in basis,” assets transferred during lifetime continue to have a carryover income tax basis to the recipient. With fewer taxpayers currently subject to the estate, gift and generation-skipping transfer taxes under the larger lifetime exemption amounts under the TCJA, the income tax benefit of the step-up in tax basis from an asset being included in your taxable estate may be greater than the future estate tax benefit of a lifetime transfer. For this reason, it should be noted the potential income tax planning opportunities often are more important now under the current tax law than the estate tax opportunities. This is a potentially significant shift in the focus of your overall estate transition plan.
Another new issue to consider is the potential effect of taking advantage of the typically beneficial portability election (which allows for both spouses’ exemption to be available at the second death) if there’s a “clawback” provision after a reduction in the exemption. It’s unclear whether the IRS would attempt to clawback the unused exemption of the first-to-die spouse over the lower exemption amount applicable at the second spouse’s death. Proper use of a bypass trust, rather than a reliance on portability, could reduce or eliminate this risk.
We suggest taking a fresh, new look at your plan, including a review of your current assets and legal documents, entity structure, income tax issues, etc., to help ensure that it still accomplishes your objectives.
For more information on year-end planning, contact Donna or your trusted BKD advisor.