A Discussion of the Tax Cuts & Jobs Act as being discussed, as it has to do with Estate Planning
As most of us know, the Republicans in the US Congress, comprising the House of Representatives and the Senate, are now discussing our future Tax “opportunities." No, you did not miss the memo, they did not ask us what we would like, but we are used to that by now. So far, the House has come up with a plan and the Senate has reviewed their plan and has come up with an alternative plan. There are some things that affect our Estate Planning option and others that could affect our other tax options. I am going to discuss where we are on both, but today, I want to put our attention on how these plans, if they come about, will affect our Estate Planning Activities.
Before we go forward, I need you to realize that none of this is law yet. They both have to agree, and then we need our President NOT to veto what is agreed upon. So, don’t get anxious and go out and change your estate planning documents today, but if things are approved, you may have to do some updating soon!
So now, the TAX CUTS AND JOBS ACT, TCJA as it is called, which was introduced this month, November of 2017, contains some interesting and fairly significant changes to the Federal Tax Code. Let me first remind you of what the current administration had stated they would do for us as it has to do with taxes during their plea for presidency. Among others were the following:
Federal Estate Taxes would be eliminated
The step-up in basis on assets after death would be eliminated
Gift taxes may be repealed
Stretch IRA benefits may be changed or repealed
These, as we know, were just a few of the changes promised, but we have been waiting for almost a year now (which is not uncommon) to see what would come to fruition. With the TCJA being discussed in both the House and the Senate, and with nothing yet set in stone, here are some of the things that could tell us how our Taxes will be handled in the coming years. (This discussion will be Federal law, not individual State law, although we may dabble in that topic a bit also).
I would say the most significant change in the TCJA, from an Estate Planning Perspective, is the possible repeal of the Estate Tax after December 31, 2023. Estate tax is a Federal Tax on what we owned, whether personally or in a Living Trust, called our "Estate”, on the day of our death. A little history on that is as follows:
Although there was a history of estate tax prior to 1996, we will start there. There has always been an “Exemption” or part of the estate that was exempt from paying estate tax. The exemption has changed over the years. However, the Exempt part of your estate had NO ESTATE TAX due on it. For an example, if you had a $1,000,000 estate and the exemption was $500,000, then, in this example, the first $500,000 of your $1,000,000 estate would be Tax Free, and the rest would be taxed at the Tax rate at that time. Tax rates during that time have ranged from 37% to 55%. So, knowing the exemption amounts and tax rates are critical when doing Estate and Tax Planning. The Exemption amounts since the year 1996 were as follows:
Year Exemption Tax Rate Occurrence
1942-1977 $30,000 77%
1977-1986 $120 – $500k 70-55%
1987 –1996 $600,000 77-55%
1997 $600,000 37-55% Bush Tax Reform Act #1 Enacted
1998 $625,000 37-55%
1999 $650,000 37-55%
2000 $675,000 37-55%
2001 $675,000 37-55% Bush Tax Reform Act #2 Enacted
2002-2003 $1,000,000 37-50%
2004 – 2005 $1,500,000 48%
2006-2008 $2,000,000 46%
2009 $3,500,000 45%
2010 Under the Bush Tax Reform Act, estate tax was repealed for a year, and Sunset Clause would bring the taxes back to where they were at the time before the 2nd Tax reform act was enacted in 2011
2010 What Really Happened: The Federal Administration, on December 17, 2010 revoked the repeal of estate Tax but brought the Exemption to a higher rate and tax rate down. $5,000,000 35%
2011 $5,000,000 35% The Obama Administration made permanent the Exemption but not the Tax Rate, repealing the Sunset Clause and Adding a “Cost of Living Increase” each year
2017 $5,490,000 40% with cost of living increases each year.
So, now with an understanding of where we have been, let’s see what direction we may be going. At the moment, on the House version, TCJA actually suggests repealing the Estate Tax all together. The current version of TCJA does not address repealing the Estate tax exemption. We need to remember, however, that even if TCJA repeals the act, it could be brought back in the future. That has happened multiple times in the past. Also remember that TCJA is a Federal Rule and does not change anything that has to do with State rules. At this time, many states have their own “Death Tax” rules and they would remain the same or could be adjusted under the new Federal Rules. California already has something before the Legislature which will create a NEW California Estate Tax at 40% but with a much smaller Exemption amount if the new Federal Laws actually do Repeal the current Federal Estate Tax rules. So, we may hope that TCJA does not actually repeal the estate tax, but takes on the other possible Changes being discussed.
Even if the House’s version of the TCJA is adopted, the elimination of the Estate tax will not be effective for almost 5 years, but it does give some interim relief by upping the Exemption amounts. Currently, as of January 1, 2017, the exemption amount is $5,490,000 per person, or $10,980,000 for a married couple (as long as your estate documents are drafted correctly, and you hold your property correctly in order to receive this benefit). If TCJA is not drafted into law, then next year, the inflation adjusted rate for each person in 2018 will be $5,600,000 per person, or $11,200,000 for a married couple.
If, however, TCJA is adopted and becomes law, the interim provisions of the Act for 2018, doubles the currently scheduled exemption to $11,200,000 per person, or $22,400,000 for a married couple. This exemption rate will then increase annually for inflation, as it does now. The tax rate will remain at the current rate of 40% until the repeal becomes effective. The house version of TCJA also eliminates the Generation Skipping Transfer Tax, or as it is known, the GST, if TCJA goes into effect on December 31, 2023 as it is suggesting. That, however, is a discussion for another day.
The Senate’s version of TCJA dos not repeal the estate to or the GST. It does, however, double the current estate tax exemption for 2018 exemption to $11,200,000 per person, or $22,400,000 for a married couple, along with annual increases for annual inflation.
Although Trump’s Platform included an imposed Capital Gains Tax on appreciated assets at the date of death, we currently get a stepped-up basis on appreciated assets when we die. So if a couple had a rental property they purchased for $100,000 and it appreciated to a value of $300,000, if you sold it you would need to pay capital gains tax on the growth (the capital gain) above the $100,000 you paid for it. There are other considerations such as improvements made and depreciation, but let’s make it simple here. At a long term Capital Gains Tax rate of 15% and California around 8%, this could vary, you would end up paying almost $50,000 in Tax.
The way the law reads now, and this does not apply to retirement accounts, if you or your spouse were to die, and your estate documents were updated after 2010 and correctly done, there would be a full Step-up in Basis (or what the taxing authorities say you paid for the property) to the current market value. In this example, $300,000 instead of the $100,000, and if the surviving spouse were to sell the property, there would be NO capital gains tax, and the surviving spouse would save about $50,000 in tax. Then, when the surviving spouse passes away it all happens again and we get another Step-up in Basis and the kids will receive the property tax free. The TCJA is not showing from either the house or the Senate version, that this benefit would be done away with.
The House version of TCJA does not get rid of Gift tax – probably to stop income tax manipulation. If there were no gift tax, highly appreciated assets could be transferred form a taxpayer with a high tax bracket, to a taxpayer with a low tax bracket for sale. Then, after the sale and payment of the lower taxes, the balance of the assets could then be transferred back to the original owner. What the House version of the TCJA did, however, is lower the tax rate to 35% from 40% for gifts made in 2024 and thereafter.
The last main item in the TCJA that could affect your estate planning needs has to do with the Stretch IRA rules that originally came into effect in 1997, allowing the inheritors (with some limitations) of your IRA or 401(k) or other retirement plans, to take the distributions from the IRA over time, thus, allowing the inheritor to pay tax only on the portion of the inherited IRA that is distributed under actuarial rules. There is nothing in either version of the TCJA to limit or affect the benefits of this type of planning.
I know, this is quite a mouthful, but it will be important to see what actually comes into law, so that we will know how to Plan our Estate after TCJA has become law.
Feel free to contact me for further information HERE. Once again, just learning so that we can keep what we have. Tax Planning is a major part of Asset Protection Planning.