On Dec. 20, 2017, Congress passed far-reaching changes to the IRC that were signed into law by the president on Dec. 22, 2017 as Public Law 115-97 (the “2017 Tax Reform Act,” also informally known as the “Tax Cuts and Jobs Act”).  The new tax law provides significant estate planning opportunities for high net worth individuals to take advantage of a temporary doubling from $5,000,000 to $10,000,000 (subject to indexing) of the estate, gift, and generation-skipping transfer (“GST”) tax exemptions.  This temporary doubling of the federal estate, gift, and GST tax exemptions (as indexed) from $5,490,000 in 2017 to approximately $11,180,000 per person (and to approximately $22,360,000 for a married couple) as of Jan. 1, 2018 creates both (1) a window of opportunity for gifting due to the significant expansion of federal gift and GST tax exemptions and (2) a need to review existing wills and other estate planning documents to ensure that they continue to carry out planning objectives.  (The actual amounts of the new exemptions are subject to confirmation by the IRS.)

Sunset of the Expanded Exemptions in 2026 Back to Pre-2018 Exemption Levels

There is a significant wrinkle in the new law, however, as it “sunsets” its doubling of the federal estate, gift, and GST tax exemptions on Jan. 1, 2026, reverting to their pre-2018 exemption levels as indexed for inflation. This will create incentive for wealthy individuals to begin to use their increased exemptions at the risk of losing them come 2026. 

That being said, there is some concern that the sunset provisions of the new law could potentially pose a “clawback risk” if an individual were to gift away his or her entire gift tax exemption during that person’s lifetime and then die after Dec. 31, 2025—at a time at which the unified estate and gift tax exemption was less than the amount that the individual had gifted away during that person’s lifetime. Congress has recognized the need to address this potential issue by authorizing the U.S. Department of the Treasury to issue guidance. Specifically, new IRC section 2001(g)(2) provides as follows:

(g) Modifications to tax payable.—

 (2) MODIFICATIONS TO ESTATE TAX PAYABLE TO REFLECT DIFFERENT BASIC EXCLUSION AMOUNTS.—The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out this section with respect to any difference between—

(A) the basic exclusion amount under section 2010(c)(3) applicable at the time of the decedent's death, and

(B) the basic exclusion amount under such section applicable with respect to any gifts made by the decedent.

It is anticipated that the U.S. Department of the Treasury, in accordance with Congress’s mandate, will provide guidance to eliminate this clawback risk.

Estate Planning with an $11,180,000 Exemption ($22,360,000 for a Married Couple)

Under the new tax law, individuals are now able to transfer approximately $11,180,000 free of estate, gift, and GST tax during their lives or at death.  A married couple will be able to transfer approximately $22,360,000 during their lives or at death. Due to the portability of the deceased spouse’s unused exclusion amount, any unused federal estate tax (but not GST tax) exemption for the first spouse to die may be used by the surviving spouse for lifetime gifting or at death. (The new tax law did not change the 40% tax rate for estate, gift, and GST taxes, or modify the rules providing for a step-up in basis to fair market value at death that generally apply to most inherited property.)

Individuals who previously exhausted their $5,490,000 gift tax exemption now have the opportunity to gift another approximately $5,690,000—or approximately $11,380,000 in the case of a married couple who has previously exhausted their gift tax exemptions—and can even make such gifts to grandchildren or more remote descendants (or to trusts for their benefit) without incurring a GST tax.  

The annual exclusion-gifting amount was $14,000 (or $28,000 if spouses elect to split gifts) for gifts made in 2017. This amount is subject to indexing in future years and is expected to increase to $15,000 (or $30,000 if spouses elect to split gifts) for gifts made in 2018. (The amount of the gift tax annual exclusion awaits confirmation from the IRS.)   

The increase of the exemptions gives individuals vast opportunities to leverage their gifting for multiple generations through the following techniques:

• topping off prior planning by making gifts to existing and/or new family trusts, including generation-skipping trusts, insurance trusts, spousal lifetime access trusts (“SLATs”) and grantor retained annuity trusts (“GRATs”)
• making new sales to intentionally defective grantor trusts (“IDGTs”) or, where appropriate, making cash gifts to facilitate the prepayment of existing installment obligations to senior family members
• making new intra-family loans or, where appropriate, cash gifts to facilitate the prepayment of existing loans from senior family members.

Special Considerations for New York Residents: Expanded Federal Exemptions Give New Yorkers Greater Opportunities to Plan Ahead to Reduce Their New York Taxable Estates and to Avoid the New York Estate Tax Cliff

New York State enacted legislation in 2014 reforming its estate, gift, and GST tax laws.  One of the major changes of the 2014 New York tax law was the gradual increase of the New York State estate tax exclusion from $1,000,000 to the federal level—anchored, however, to the exemptions provided under then-existing federal tax law. As of April 1, 2017, the New York estate tax exclusion amount increased from $4,187,500 to $5,250,000. The New York estate tax exclusion amount is scheduled to increase further on Jan. 1, 2019 to $5,000,000, as indexed for inflation with 2010 as the base year for this purpose (this amount will very likely exceed $5,600,000). 

Planning to maximize the use of both spouses’ New York exclusion amounts is a bit tricky because New York does not recognize portability of a deceased spouse’s unused exclusion amount to the surviving spouse, as federal law does. As a result, many New Yorkers will continue to incorporate credit shelter trusts or disclaimer trusts in their wills to maximize the benefits of both New York and federal law exclusion amounts.

A dramatic consequence to New Yorkers of the doubling of the federal estate tax exemption under the 2017 Tax Reform Act is that there is now an approximately $5,930,000 spread between the federal and New York State estate tax exemptions. Furthermore, the benefits of an increase in the New York exclusion amount are effectively denied to wealthier New Yorkers. There is a cliff built into the tax calculation, which quickly phases out the benefits of the exclusion if the decedent’s New York taxable estate (plus certain taxable gifts made within three years of death) is between 100% and 105% of the exclusion amount available on the date of death. The cliff completely wipes out the benefits of the exclusion if the decedent’s New York taxable estate (and any such gifts added back) exceeds 105% of the exclusion amount available on the date of death. As a result, the increase in the New York estate tax exclusion amount only benefits individuals whose New York taxable estates (including taxable gifts made within three years of death) fall below the New York exclusion amount in effect on the date of death. The New York estate tax exemption is also not portable to spouses for lifetime gifting or for use on the survivor’s New York estate tax return, in sharp contrast to the federal estate tax exemption.

A comparison of the “spread” between the federal and New York State estate tax exemptions under both prior law and the 2017 Tax Reform Act is set forth below.

Prior Law

2017 Tax Reform Act

*based on 2018 inflation-adjusted amounts, but could be higher

As a result of the dramatic spread between the federal and New York estate tax exemptions, decedents whose estates are below the Federal estate tax exemption amount may still owe significant New York estate tax if their estates exceed the New York estate tax exemption amount.  For example, if an unmarried New York resident dies in 2018 with an estate of $10,000,000 (assuming no lifetime gifts were made), he or she will owe no federal estate tax but will owe $1,067,600 in New York estate tax (based upon current rates).

New Yorkers whose estates are within the 100%-105% “cliff” range—or even whose estates only slightly exceed the New York estate tax exemption amount—may consider gifting such amount as would bring his or her taxable estate below the New York estate tax exemption amount. As an example, an unmarried New Yorker who has assets with a current value of $6,000,000 and is in relatively good health may wish to consider gifting $400,000 at this time to his or her children or other intended beneficiaries. If such person dies more than three years after making the gift (or after the three-year add back rule has expired—it is currently scheduled to expire for individuals who die on or after Jan.1, 2019), when the New York exclusion amount will be $5,600,000 or greater, with a taxable estate of $5,600,000, his or her estate will owe no New York or federal estate tax.  

In contrast, if the gift is not made and the person dies on Jan. 1, 2021, with a taxable estate of $6,000,000, the estate will owe $510,800 in New York estate tax (based upon current rates). To summarize, by making a gift of $400,000 today, an individual can save his or her beneficiaries over $500,000 in New York estate tax if he or she survives three years after making the gift. This recommendation will not be affected by any subsequent changes to the federal estate, gift, and GST tax laws.

A further benefit to New York residents making lifetime gifts within the parameters of the expanded federal exemption is the ability to move assets out of the New York taxable estate without incurring any state-level gift tax. New York has no gift tax and adds back to the gross estate of New York resident decedents only certain gifts made within three years of death. As a result, New Yorkers have the ability to insulate gifted property from New York estate tax (provided that the donor survives for three years) and may have the added benefit of reducing their New York taxable estate below the applicable exclusion amount on the date of their death.  This can avoid the confiscatory impact of the “New York Estate Tax Cliff.” 

For example, a gift of $11,180,000 by a New York resident who survives the gift by three years can potentially save $1,788,800 of New York State estate tax (and possibly even more than that if the New York Estate Tax Cliff would otherwise apply). The New York estate tax savings could potentially be doubled (to $3,577,600) if both spouses were to fully use their federal exemptions by making lifetime gifts and each spouse survives the gift by three years.

The potential tax savings of such a gifting program should also be considered in tandem with the temporary expansion of the federal estate, gift, and GST tax exemptions before the expanded federal exemptions revert to pre-2018 exemption levels on Jan. 1, 2026.  If one were also to factor in the sunset of the doubling of the federal estate, gift, and GST tax exemptions on Jan. 1, 2026 back to pre-2018 exemption levels, the combined federal and New York State estate tax savings from such gifts at this time would be increased by another approximately $1,800,000 ($3,600,000 for a married couple) to more than $3,500,000 for an individual and to more than  $7,000,000 for a married couple, as compared to persons who do not embark on a gifting program and allow their expanded federal exemptions to revert to pre-2018 exemption levels on Jan. 1, 2026.

Popular Wealth-Transfer Techniques to Leverage Expanded Federal Gift and GST Tax Exemptions Remain Viable

In light of the significant increase to the federal estate, gift, and GST tax exemptions under the 2017 Tax Reform Act, individuals who wish to reduce or eliminate future estate taxes may consider maximizing their use of the increased gift tax exemption before the exemptions revert to pre-2018 levels on Jan. 1, 2026.  Strategies that remain viable and attractive include dynasty (generation-skipping) trusts, SLATs, GRATs, intra-family loans, and sales to intentionally defective grantor trusts.

Dynasty (Generation-Skipping) Trusts

Through coordinated use of their federal gift and GST tax exemptions, individuals can create trusts with an aggregate value of up to approximately $11,180,000 (approximately $22,360,000 per married couple), which may benefit several generations of descendants while insulating the assets from gift, estate, and GST taxes. These are sometimes referred to as “dynasty trusts.”  

Dynasty trusts are generally structured as “intentionally defective grantor trusts” (or “IDGTs”). An IDGT provides two independent planning opportunities. First, the grantor will pay the income tax on the income generated by the trust, including capital gains tax, thereby allowing the trust to grow for the grantor’s children and their issue while unencumbered by the income tax and  while reducing the grantor’s estate. Second, the grantor may engage in transactions with an IDGT without any income tax consequences. (See Revenue Ruling 85-13.) 

Spousal Lifetime Access Trusts (“SLATs”)

Dynasty trusts may also be structured to give the grantor’s spouse access to the trust as a discretionary beneficiary of trust income and principal. Such trusts can provide comfort that transferred wealth would still be available for a married couple if needed down the road, and they can essentially serve as a “rainy day fund” while allowing one to take maximum advantage of the new tax laws. Such trusts with spousal access rights are sometimes referred to as “spousal lifetime access trusts,” or “SLATs,” and they will generally be grantor trusts for income tax purposes during the grantor’s lifetime. 

Taking Advantage of Extraordinary Planning Opportunities Now

Under the 2017 Tax Reform Act, the federal gift, estate, and GST tax exemptions increased to approximately $11,180,000 on Jan. 1, 2018 (approximately $22,360,000 for a married couple), allowing individuals extraordinary multi-generational estate planning opportunities to use these exemptions through lifetime gifting before the exemptions revert to their pre-2018 levels on Jan. 1, 2026.  Selecting the optimal wealth transfer technique and the right assets to gift (taking into account the income tax basis of the assets to be gifted) are of paramount importance.  

Kevin Matz, Esq., CPA, LLM (Taxation),