Tax Reform and Your Estate Plan: What to Watch For
While Congress has not yet sent a tax bill to the President's desk, both the House and Senate have passed their own versions of a sweeping tax reform bill that has implications for many estates. This article explores the changes to the federal estate tax, gift tax, capitals gains tax, and steps you should take to review your estate plan.
Estate Tax Repeal - Maybe
The tax bills passed by the House and Senate immediately doubles the federal estate tax exemption. With adjustments for inflation, this means that a person dying in 2018 could pass over $11 million to his or her heirs without owing any estate tax. Through the use of portability, a married couple could pass over $22 million to their heirs without owing any estate tax.
The current exemption levels are $5.49 million for individuals dying in 2017 and close to $11 million for married couples.
Under the House bill, the federal gift and estate tax would be fully repealed in the year 2024. The Senate bill, on the other hand, would keep the higher exemption amounts but would not repeal the estate tax.
Gift Tax Annual Exclusion Amounts
Both the House and Senate plans would increase the annual gift tax exclusion amount to $28,000 per person and $56,000 per couple. Under the current law, any gifts made to an individual of more than $14,000 (or $28,000 for a married couple) per year must be reported to the IRS and will reduce the donor's federal gift and estate tax exemption amount.
Stepped Up Basis
Both the House and Senate tax bills retain the stepped-up basis rules. Stepped-up basis is hugely beneficial for heirs of appreciated property.
For example, if a decedent owned stock that he purchased in 1965 for $10 per share (his basis) and in 2017 it is worth $100 per share, there is a $90 per share gain. If the decedent sold the stock before his death, he would owe capital gains tax on the $90 per share gain. If, however, the decedent holds the stock until his death, the heirs receive a new basis equal to its value on the date of death ($100 per share). If they then turn around and sell it for $100, they have no gain and will owe no capital gains tax. Under the House plan, the heirs would also owe no federal estate tax.
Don't Forget: Minnesota has an Estate Tax
Although the federal estate tax may be repealed or affect many fewer people, it is important to remember that Minnesota has an estate tax! The Minnesota estate tax has a much lower exemption amount. Individuals dying in 2017 can pass up to $2.1 million to their heirs without owing any Minnesota estate tax. This amount is set to increase until the year 2020, when individuals can pass up to $3 million to their heirs without owing any Minnesota estate tax.
The Minnesota estate tax law, however, does not include portability like the federal estate tax law. Portability allows married couples to share their exemption amounts so that they can essentially double the amount they can pass to their heirs. In Minnesota, married couples must use trusts and set up their estate properly to allow them to double their exemption amounts. So, a Minnesota couple with a sound estate plan could pass up to $6 million to their heirs without owing any Minnesota estate tax (in 2020 and later).
Minnesota farmers and small business owners should also plan carefully to be sure their farm and business assets qualify for the Minnesota qualified family farm land and small business deduction. If a farmer or small business owner meets the qualifications of these deductions, he or she may be able to pass up to $5 million to heirs without owing any estate tax.
For most Minnesotans, repeal of the federal estate tax will not have much impact. However, there are some situations where trustees and spouses should review current trusts and estate plans.
If the federal estate tax is repeal or increased to such a level that your estate is no longer affected, you should review the funding language in your trust for what happens after the death of a spouse. You might wish to revise your funding language to have more flexibility and control so your surviving spouse can make informed decisions at the time of death that reflect the changing estate tax situations.
For example, many trusts include formula funding language that require credit shelter trusts to be funded with an amount essentially equal to the exemption amount in the year of death. In Minnesota, the exemption amount is increasing to $3 million in the next few years. If a person dies with a $1 million estate, the trust may require the entire estate to be allocated to a credit shelter trust (which will then cause the assets to be "locked in" for basis purposes). If a married couple has a joint estate of less than $3 million, there may be very little need to fund a credit shelter trust at any level.
Another example makes this point even starker: consider a married couple that are residents of a state that has no state estate tax. The only estate tax that impacts them is the federal estate tax. Assuming the House bill proceeds and the estate tax is repealed in the year 2024, a formula funding clause in a trust would still require a credit shelter trust to be funded at the death of a decedent - even if the death occurred in the year 2023! If the surviving spouse lives for many years after the death, this could potentially cause a significant inadvertent increase in capital gains taxes for the heirs.
Trustees of a credit shelter trust should review the trust in the context of higher exemption amounts and consider whether action should be taken to attempt to terminate the trust. In some cases, assets may be distributed from the credit shelter trust and to the surviving spouse. This will allow the surviving spouse to hold the assets until his or her death - thereby permitting the heirs to a receive a stepped-up basis in the assets and lowering the capital gains they may eventually pay.
If either bill is passed into law, it does present an opportunity for accelerated gifting of farms and family businesses by doubling the annual gift exclusion amount. Since Minnesota has no gift tax, and the estate tax incorporates the federal gift tax by reference, these gifts would be excluded under current Minnesota law as well.
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