The Tax Cuts and Jobs Act (TCJA), which generally went into effect at the beginning of 2018, lowers individual and corporate tax rates, reduces or eliminates many deductions and enhances other tax breaks. One thing the new law doesn’t do is repeal the federal estate tax. But the TCJA does include other provisions that can impact your estate plan.
Higher exemption amounts
The biggest change the TCJA makes related to estate planning is the doubling of exemption amounts for the gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption. For the estates of persons dying, and gifts made, after December 31, 2017, and before January 1, 2026, the gift and estate tax exemption and the GST tax exemption amounts increase to an inflation-adjusted $10 million, or $20 million for married couples with proper planning (expected to be $11.2 million and $22.4 million, respectively, for 2018). The top marginal tax rate for all three taxes remains at 40%.
That’s good news for those with large estates, but it’s important to note that — absent congressional action — the exemption amounts will revert to a $5 million base (adjusted for inflation) in 2026. Therefore, if you have an estate in excess of around $5 million (or around $10 million with your spouse), you should consider making tax-free wealth transfers that take advantage of the higher exemption amount before it potentially “sunsets.”
You have several options for such transfers beyond direct gifts to your loved ones, including:
- Gifts to existing or new irrevocable tr usts,
- Gifts to fund life insurance that can be used to pay estate taxes, and
- Gifts tied to philanthropy (for example, a charitable lead trust).
You also might consider establishing a disclaimer trust that allows the surviving spouse to minimize taxes by “disclaiming” part or all of his or her inheritance into a bypass (or credit shelter) trust, where it won’t be considered part of your estate. Thus, if the exemption amount has dropped to a level where estate taxes would be due, your surviving spouse can avoid the taxes by moving part of your estate to the trust.
Bear in mind, too, that some states have their own estate taxes. The exemption amount in those states are likely to be significantly lower than the federal amounts.
Expanded 529 plans
The TCJA also expands the tax benefits of 529 plans, which families can use to grow money tax-free for their children’s education. Distributions are tax-free when used to pay qualified expenses such as tuition, fees, books, room and board, and the purchase of computer technology or equipment, Internet access or related services.
Previously, tax-free treatment of 529 plan distributions was limited to higher education expenses, but the TCJA also allows them for qualified public, private and religious elementary and high school expenses — up to $10,000 per beneficiary annually. Contributions to 529 plans might be an appealing option for grandparents looking to pare down their estates while benefiting their families.
Kiddie tax rates
One popular way of reducing taxable estates has long been to make gifts to children or grandchildren. You can make nontaxable gifts of $15,000 per individual per year. Rather than making outright gifts, many parents and grandparents set up investment accounts in the children’s names and make gifts to those accounts.
Until now, generally unearned income collected by a child under age 19 or a full-time student under age 24 that exceeded a threshold amount ($2,100 for 2018) was taxed at the parent’s tax rate (if higher than the child’s). Unearned income includes dividends, interest and capital gains distributions from investments. The intention of this “kiddie tax” is to discourage “shifting” of income in an effort to minimize income taxes.
The TCJA makes the kiddie tax an even stronger disincentive: For 2018 through 2025, a child’s net unearned income over the allowed amount, as adjusted for inflation, will be taxed according to the brackets for trusts and estates. The trust and estate brackets have the same top rate as the individual taxpayer brackets (now 37%), but that rate is triggered much sooner — when taxable income exceeds $12,500. For single filers in 2018, the top rate doesn’t kick in until taxable income reaches $500,000, and for married couples filing jointly, the top rate begins at taxable income of $600,000.
Time to review your estate plan
The estate-tax-related provisions of the TCJA may call for a rethinking of your gifting and overall estate planning strategies. We can help you review and (if necessary) revise your estate plan to maximize the benefits and minimize negative consequences.