It’s been four months since the new tax deal became law, and pundits are still weighing
in on the merits and flaws of the program. This month’s blog will discuss the new deal
from the perspective of estate planning. For our purposes, the law’s most notable
provision is a raising of the estate tax exemption to $11.2 million (or $22.4 million for married
couples). With that said, the law won’t have a significant impact on the majority of
Americans, but it is worth noting who will be affected by the law, and how. Let’s jump in …
1. The Estate Tax will affect fewer Americans.
Okay, that’s good right? Well, yes, but let’s not gloss over this point. If your current estate plan includes a trust that was created when the exemption was lower, it’s possible that it might be unnecessarily restrictive under the new program. In reviewing older plans, I not uncommonly come across mandatory bypass provisions and/or credit shelter trusts. These may have been useful when the estate tax exemption was below 1 million dollars, but now with it hovering at 11.2 million dollars, they create more issues than solutions. Sometimes, these plans were sold to clients who didn’t need them to begin with. Generally speaking, I advise my clients to create plans that are not unnecessarily complex in order to simplify the proceedings for beneficiaries left behind.
Let me give you an example from a client I worked with about 5 years ago. The client and his wife had a combined total estate worth of less than 200 thousand dollars. He came to see me shortly after his wife passed away and I reviewed the will that had been set up for her a few years earlier. I was shocked to see that it created a mandatory bypass trust, a stipulation that placed her one-half community interest in a bypass trust. The end result? Her half of the estate, which primarily consisted of their homestead, was placed into a trust. For my client, a widower in his nineties, this was an unnecessary hiccup. There was no need for a separate trust. Their estate would have owed no taxes regardless of the planning technique used. As it was written, however, the wife’s will did result in both unnecessary work and increased legal fees. If you have an estate plan, but don’t fully understand it, now is a good time to meet with a trusted advisor, have them explain it to you and then determine if it should be changed.
2. What if the tide turns again?
This is a great question, and a valid question. Taxes are a little bit like Texas weather. If you don’t like it, wait around a bit. With that in mind, lets dig a little deeper into the current act. Prior legislation had placed the estate tax exemption permanently at 5 million dollars adjusted annually for inflation. Permanent, of course, didn’t really mean permanent—it just meant that the exemption didn’t have a built-in expiration date. The Tax Reform act of 2018 has no permanent language. On the contrary, the act has a sunset clause, which stipulates that the estate tax provisions will expire in 2025, at which time the estate tax exemption will revert back to the prior law (the $5 million exemption). What does all this mean? It means that if you have an estate above $5 million, you should pay close attention to what congress does with the Estate Tax exemption between now and 2025. It also means that it might be prudent to start looking at some advanced planning techniques to move items out of your estate while the exemption is so high.
3. If you have significant assets, it’s still a good idea to make annual gifts.
Beginning in 2018, the amount you can gift to others has increased from $14,000 per year to $15,000 per year. Let’s have a look at our favorite imaginary couple Bob and Sally. Bob and Sally have 2 kids, Jack and Diane. Bob and Sally decide they want to start making gifts to reduce the amount of their overall estate. Bob decides to gift $15,000.00 to Jack and $15,000.00 to Diane. Sally decides to do the same. In the end, Bob and Sally have gifted $60,000.00 to their kids and reduced the value of their taxable estate upon death, with no negative tax implications today. And remember: If Jack and Diane have spouses and/or children, Bob and Sally can make gifts to them as well, reducing their taxable estate even further.
4. Remember: Taxes are not the most important aspect of estate planning.
Estate Planning should never be looked at through a microscope, but instead with a panoramic lens. Your beneficiaries’ specific needs will often trump what negative tax implications might arise. In some cases, we have to accept that paying taxes might be a necessary evil in the course of providing the best plan for your beneficiaries. The most important thing is knowing that the plan we put in place will simplify the lives of those we leave behind, not complicate it.