Tax Reform is Here: What You Need to Know

529 Plans Expanded

529 Plans are a tax-advantaged way to save for college costs. The Act expands the use of tax-free distributions from these plans, including paying for elementary and secondary school expenses for private, public, and religious school, as well as some home schooling expenses. Educational therapies for children with disabilities are also included. There is a $10,000 annual limit per student.

ABLE Accounts Adjusted

ABLE accounts, established under Section 529A of the Internal Revenue Code, allow some individuals with disabilities to retain higher amounts of savings without losing their Social Security and Medicaid benefits. The Act allows money in a 529 education plan to be rolled over to a 529A ABLE account, but rollovers may count toward the annual contribution limit for ABLE accounts ($15,000 in 2018). The Act also changes the rules on contributions to ABLE accounts by designated beneficiaries who have earned income from employment.

Temporary Doubling of Estate, Gift, and GST Tax Exemption

First, as a quick summary: The estate tax applies to transfers that happen upon your death. Gift tax applies to transfers you make while living. Generation-Skipping Transfer Tax (GST Tax) applies to lifetime or estate transfers made to “skip persons”—persons more than a generation below you such as grandchildren or great-grandchildren.

The Act doubles the estate, gift, and GST tax exemptions from $5 million to $10 million (adjusted for inflation after 2011) for estates of decedents dying, generation-skipping transfers, and gifts made after December 31, 2017 and before January 1, 2026. As a result of the Act and indexing for inflation, the estate, gift and GST tax exemption amount for 2018 is $11.2 million per person. Estate, gift, and generation-skipping transfers above the exemption remain subject to a maximum tax rate of 40 percent.

There is no provision for ultimate repeal of the estate, gift, or GST taxes. The increased exemptions remain in place until December 31, 2025, at which time they revert to the current $5 million level (indexed for inflation).

As a reminder, if you are a U.S. citizen, your estimated gross estate includes everything that you own whether it is located in the U.S. or abroad, including but not limited to: real estate, bank accounts, investment accounts, stocks, bonds, annuities, death benefits of life insurance policies, automobiles, and personal property.

The following table provides a summary on our thoughts regarding estate tax planning based upon marital status and estimated size of gross estate:

Basis Step-Up

The Act did not change the rules that allow for a step-up in basis for certain appreciated assets upon death. This is a critical provision for those with investments or property with significant capital gains and why it is often best for your children to inherit the property from you rather than gifting it to them during your lifetime.

Gift Tax Annual Exclusion

No changes were made to the annual gift tax exclusion rules other than an inflation adjustment for 2018 for an annual exclusion amount of $15,000. Gifts in excess of the annual allowance will require the filing of a gift tax return. However, you can opt to have the gift subtracted from your estate tax exemption amount ($11.2 million), meaning that for gifts below $11.2 million, no gift tax will be due though a return must still be filed if the gift exceeds the annual exclusion amount of $15,000.

As always, we would caution that although gifts below $15,000 may not be subject to gift tax, such gifts can still create significant problems for eligibility for government benefits such as Medicaid for nursing home care. If you are concerned about potential long-term care expenses, we would strongly encourage you to call our office at 919-443-3035 to schedule a consultation to discuss your planning options.

No Change to IRA “Stretch-Out” Rules

The Act did not make any changes to how retirement plans, including Individual Retirement Plans (IRAs) are distributed to beneficiaries or how the plans are taxed. For further information regarding tax planning and asset protection options for IRAs and work-based retirement plans such as 401(k) and 403(b) plans, we have a new resource, Supercharge Your IRA, available for download at vip.carolinafep.com/IRATrustGuide that provides additional information.

Transfers of Appreciated Assets to Charitable Remainder Trusts

With the capital gains rate and the net investment income tax remaining the same as under previous law, those that are charitably minded may wish to consider using charitable remainder trusts (CRTs) to sell appreciated assets. A CRT allows the client/donor to name themselves or someone else to receive payments for life or for a term of 20 years or less. Income can be paid over multiple lives, allowing income to be paid to a married couple for as long as both spouses are alive. At the end of the trust term, the trust assets pass to the named charity.

CRTs can provide significant tax savings for clients that plan to sell appreciated assets. Instead of selling the asset and paying capital gains tax, the client can transfer the asset to a CRT and allow the trust to sell the asset. The client can maintain control of the asset by serving as the trustee and receive a charitable income tax deduction in the year that the CRT is established. The amount of the deduction is based on the present value of the interest that ultimately passes to the charity. The charity is tax-exempt and can sell the appreciated asset with no tax consequences. This technique allows the client to keep control over the property during life and obtain an up-front tax deduction while allowing the charity to receive the full value of the remainder interest, without reduction for tax on the asset’s appreciation.

Due to the involved nature of this type of planning and costs associated with establishing a CRT, this strategy is best considered for those considering charitable donations of $250,000 or more. For donors who are considering charitable donations of $250,000 or less, other options include direct donations (including donating appreciated stock or assets), bequests in your will or trust, donor-advised funds, or similar.

Planning Strategies for Those with Estimated Estates
in Excess of $5.6 Million (Single) or $11.2 Million (Married)

Lifetime Gifting

The doubling of the estate, gift, and GST tax exemptions means that, beginning in 2018, taxpayers can transfer up to $11.2 million of assets without transfer tax consequences. This creates significant gifting opportunities between January 1, 2018, and the sunset of the increased exemptions on December 31, 2025.

Spousal Lifetime Access Trusts

Some clients who would otherwise make gifts to irrevocable trusts for tax planning purposes may be reluctant to do so because of the loss of control. These clients may be concerned that lifetime gifts will deplete their funds to such an extent that they can no longer support their current and future lifestyle. For married clients, these concerns can be alleviated with a spousal lifetime access trust (SLAT).

A SLAT allows one spouse (donor spouse) to make a gift to a non-reciprocal, irrevocable trust that names the donor spouse’s spouse (beneficiary spouse) as a lifetime beneficiary of the trust. The beneficiary spouse or the couple’s children may serve as the trustee if his or her discretion is limited by an ascertainable standard (i.e., distributions can be made for health, education, maintenance or support). The gift constitutes a completed gift to remove the asset from the donor spouse’s estate, but ensures that the donor spouse will still have access to trust assets through the beneficiary spouse as long as the couple remains married to each other.

Clients should evaluate whether to establish SLATs (or make transfers to existing SLATs) before the increased exemption amounts expire. As long as the gifts to the trust are below the increased exemption amount, a transfer to a SLAT may offer increased protection against future changes to the tax laws with little downside risk.

Opportunities for GST Planning

The increased exemption amounts also create opportunities for Generation Skipping Transfer (GST) tax planning. For example, grandparents can combine lifetime gifting with GST tax planning and make lifetime gifts directly to their grandchildren instead of their children. This would be particularly beneficial in light of the December 31, 2025, sunset of the increased exemption amounts because it will allow an additional $5 million of assets (twice the current exemption amount) to escape estate taxation at the children’s death, by which time the exemption amounts will likely have reverted back to the 2017 levels.

Instead of making outright gifts to skip persons (e.g. grandchildren), clients can also establish a GST trust and allocate the increased exemption amount to such trust, rendering it fully exempt from GST tax even when the increased exemption sunsets.

What’s Next?

Given the broad scope of the changes made by the Act, expect there to be some adjustments and clarifications as the new tax bill goes into effect.

As for your existing estate planning, we are working systematically to review the plans for members of our VIP Inner Circle program to evaluate whether any planning changes are recommended. We appreciate your patience as we work to keep this as smooth and organized as possible. If you feel that your planning review warrants expediting due to significant health-related concerns or other extenuating circumstances, please contact us to discuss.