In December 2017, Congress passed the Tax Cuts and Jobs Act that changes significantly tax planning for corporations, small businesses and individual creating unprecedented planning opportunities for both individual and business clients.
This memo focuses on some of the estate planning implications:
The doubling of the estate, gift and generation-skipping tax (“GST”) exemptions means that, beginning in 2018, taxpayers can transfer up to $11.2 million of assets without transfer tax consequences. Between January 1, 2018 and the sunset of the increased exemptions on December 31, 2025, clients have the opportunity to remove assets from their estates and exempt future appreciation from taxation.
Whether a client should make taxable gifts depends on many factors, including the effect of state-level estate taxes and the tax basis of the property to be gifted. If the client is considering gifts for non-tax reasons (such as asset protection), the increased exemption amount may be enough to tip the scales in favor of a lifetime gift. This is especially true if the client has a gross estate significantly above the exemption amount.
Spousal Lifetime Access Trusts
Some clients who would otherwise make gifts to irrevocable trusts for tax planning purposes may be reluctant to do so because of the loss of control. These clients may be concerned that lifetime gifts will deplete their funds to such an extent that they can no longer support their current and future lifestyle. For married clients, these concerns can be alleviated with a spousal lifetime access trust (SLAT).
A SLAT allows one spouse (donor spouse) to make a gift to a non-reciprocal, irrevocable trust that names the donor spouse’s spouse (beneficiary spouse) as a lifetime beneficiary of the trust. The beneficiary spouse or the couple’s children may serve as the trustee if his or her discretion to make distribution of trust assets is limited by an ascertainable standard. The gift constitutes a completed gift to remove the asset from the donor spouse’s estate, but ensures that the donor spouse will still have access to trust assets through the beneficiary spouse as long as the couple remains married to each other. The SLAT may also give the beneficiary spouse a limited (but not a general) power of appointment to distribute assets among the couple’s children after the beneficiary spouse’s death.
Clients should evaluate whether to establish SLATs (or make transfers to existing SLATs) before the increased exemption amounts expire. As long as the gifts to the trust are below the increased exemption amount, a transfer to a SLAT may offer increased protection against future changes to the tax laws with little downside risk.
Opportunities for GST Planning
The increased exemption amounts also create opportunities for GST tax planning. For example, grandparents can combine lifetime gifting with GST tax planning and make lifetime gifts directly to their grandchildren (skip persons) instead of their children. This would be particularly beneficial in light of the December 31, 2025, sunset of the increased exemption amounts because it will allow an additional $5 million of assets (twice the current exemption amount) to escape estate taxation at the children’s death, by which time the exemption amounts may have reverted back to the 2017 levels.
Instead of making outright gifts to skip persons, clients can also establish a GST trust and allocate the increased exemption amount to such trust, which may render it fully exempt from GST tax even when the increased exemption sunsets. For clients with existing trusts to which no GST tax exemption was allocated, 2018 (until the sunset) may be the time to make a late allocation. For clients with existing GST tax exempt and non-exempt trusts, the period of increased exemption could be the ideal time to make distributions out of the non-exempt trusts either directly to skip person beneficiaries or to a GST tax exempt trust.
Assuming there is no clawback of any or all of the doubled exemption amount, a proper allocation to a trust of the increased GST exemption amount should render the trust fully exempt from GST tax for the duration of its term, even after the reversion of the exemption amount back to the 2017 level. It is important to remember that there is no portability of the GST exemption, so each person must use his or her exemption either during lifetime or on death. Otherwise it is lost.
Domestic Asset Protection Trusts and Hybrid Domestic Asset Protection Trusts
Now may be the best time in a client’s life to contribute to self-settled domestic asset protection trusts (DAPTs). This is especially true for unmarried clients that cannot use the SLAT strategy described above. There are various ways that DAPTs can be designed with built-in flexibility, such as by naming a trust protector or non-fiduciary with authority to add the grantor back as a trustee at a later time (hybrid DAPT). Establishing and funding a DAPT not only removes assets (including future appreciation) from the estate, but also provides ongoing asset protection for the term of the trust.
Review and Revision of Prior Estate Plans
All clients that have previously engaged in tax planning should revisit their estate plans, including the dispositive provisions of all testamentary and non-testamentary trusts. These plans should be evaluated for tax purposes, but—perhaps just as importantly—for non-tax purposes. For example, many estate plans make bequests equal to the federal estate tax exemption amount. Clients that may have been comfortable with a $5 million bequest may not be comfortable with a $10 million bequest, and with the built-in expiration of the increased exemption already in place, clients should consider the effect of another change in 2026.
Power of Appointment Planning
Depending on the circumstances, clients should also consider giving older, trusted relatives a general power of appointment for basis step-up purposes. Giving an elderly relative a general power of appointment over a trust can result in a basis step-up for the trust assets on the death of the elderly relative. If clients have considered this strategy but have been reluctant to move forward because of the size of the elderly relative’s own estate, those concerns may be alleviated—at least in the short term—by the increased exemption amounts.
Building Flexibility into Plans
Given the scheduled sunset of the increased estate, gift, and GST tax exemptions and the possibility that changes in Congress and the White House will change the tax laws, flexibility is more important than ever for clients with potentially taxable estates. For example, in appropriate cases trusts should include powers of appointment that allow trust assets to be re-vested in the grantor to obtain a basis step-up. Trust protectors, formula powers of appointment, and other strategies designed to future-proof planning strategies should be considered.