Estate planning for the other 99%

August 2, 2019

By Scott Swain and Nicole Rococi at The Tax Adviser on August 1, 2019

The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, made dramatic changes to the income tax regime in 2018, but it also had a significant impact on federal estate and gift taxes. Fortunately, for high-net-worth planners, the changes to the estate tax regime were simple in terms of the legislation itself. That said, the implications of the large increase in the estate and gift tax exemption are complex and affect estate planning for everyone, not just the small percentage of the population who will still file estate tax returns. This discussion focuses on how the TCJA's changes affect the 99% who will not be filing a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return.

First, a review of the changes is required. The foundation of the federal estate, gift, and generation-skipping transfer (GST) tax framework was retained, under Secs. 2001, 2501, and 2601, respectively, but the lifetime estate and gift exemption amount granted under Sec. 2010(c) was increased temporarily by adding Sec. 2010(c)(3)(C). This effectively doubled the exemption from $5 million to $10 million, which is then adjusted for inflation to arrive at the revised 2018 exemption amount of $11,180,000 per individual, up from $5,490,000 in 2017. (The Internal Revenue Code uses the term "applicable exclusion amount," but this item uses the more common term "exemption.") For 2019 the exemption increased to $11,400,000.

As noted above, this increase is not permanent and is set to sunset at the end of 2025 like the majority of the personal income tax provisions in the TCJA. When the current legislation sunsets, the exemption amount will go back to roughly $6 million after inflation adjustments. Also note that the lifetime GST exemption increased to $11,180,000 along with the estate and gift tax exemption, as the GST exemption is defined under Sec. 2631 by to the exclusion amount under Sec. 2010(c). The gift tax annual exclusion increased to $15,000 for 2018 ($30,000 for a married couple), although this was a normal inflation adjustment.

Everything else essentially stayed the same, including the tax bracket structure and maximum estate tax rate of 40%. The concept of the deceased spousal unused exclusion (DSUE) as defined under Secs. 2010(c), more commonly known as "portability," was also unchanged. Under these provisions, a married individual who does not use his or her entire estate tax exemption can carry over the balance for his or her spouse to use. The important reminder here is that a portability election must be made on Form 706 for the surviving spouse to later apply the decedent's DSUE amount to his or her own transfers. Under Sec. 2010(c)(5)(A), the election is effective only if made by the due date of the estate tax return (including extensions) for the deceased spouse. There is some relief under Rev. Proc. 2017-34 if the Form 706 due date has passed. Also note that portability does not apply to the GST exemption. This is an important planning point for those with large taxable estates in order to avoid wasting GST exemption at the first death.

That completes a summary of the current state of the estate and gift tax law. The rest of this item focuses on providing estate planning assistance for the average person.

Recall how different the landscape was 20 years ago when the estate tax exemption was $650,000 with a top tax rate of 55%. Not only that, but every state levied an estate or inheritance tax at that time. Many states had authored simple statutes that levied an estate tax equal to the amount a taxpayer could claim as a state tax credit on the Form 706. The state tax credit was phased out over time and converted to a deduction under the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16, which effectively eliminated the estate tax for many states and led others to repeal their estate tax. As of 2018, only 17 states and Washington, D.C., maintain either an estate tax or inheritance tax (Maryland is the only state with both), and the state exemption amounts have increased dramatically for a number of thosestates.

Because the exemption has increased so dramatically, the number of taxable estates has gone from small to minuscule. The most recent statistics from the Tax Policy Center, which are from 2013, indicate that only 0.18% of adult deaths resulted in a taxable estate tax filing when the federal exemption was $5,250,000. While the National Institutes of Health report 2.6 million Americans died in 2013, only 10,568 estate tax returns were filed that year, with less than half of those reporting a taxable estate, according to the Tax Policy Center. Based on these data and considering the exemption has more than doubled since 2013, it seems safe to assume that the number of taxable Form 706 filings will go down to less than 0.1% of the adult deaths for 2018 and future years.

Between the increase in the exemption at the federal level and the fact that many states eliminated their estate taxes, the playing field for estate tax planning completely changed over 20 years. Considering how infrequently the average person updates his or her estate documents — conventional wisdom is about every 20 years — one can imagine that there are a vast number of drastically outdated documents tucked away in clients' file drawers.

Estate planning has always included much more than simply strategizing about how to minimize estate taxes. Estate planning is needed to address a multitude of other nontax matters,including:

  • Custody of minor children upon the death of their parents, as well as custody of their assets;
  • Charitable goals and objectives;
  • How assets will be administered for the benefit of a surviving spouse;
  • Determination of which heirs will receive estate assets after the second death;
  • Structuring of asset distributions to these heirs, whether outright or in trust;
  • Structuring asset ownership to avoid probate;
  • Addressing complex family structures, including second marriages, stepchildren, etc.;
  • Addressing special needs or financially irresponsible family members;
  • Drafting of a durable/financial power of attorney;
  • Drafting of a health care power of attorney and living will; and
  • Review of beneficiary designations on life insurance policies and retirement accounts.

Also consider that financial institutions and medical providers are hesitant to accept power of attorney forms signed in the late 1990s. The path of least resistance is to provide copies signed in the last few years, so it is best to update theseperiodically.

Click here to continue reading.

View all News