United States: Planning One Year After The Tax Cuts And Jobs Act

Last Updated: January 17 2019
Article by Stephen C. Wallace

It has been one year since President Trump signed into law the most significant revision to the Internal Revenue Code since 1986, with the enactment of the Tax Cuts and Jobs Act (TCJA). This article highlights only a few of the many tax planning strategies available to taxpayers following the TCJA. The TCJA created significant wealth transfer planning opportunities by doubling the lifetime estate and gift tax exemption (the exemption) from $5,000,000 to $10,000,000 (indexed annually for inflation). For 2018 the exemption is $11,180,000 and for 2019 the exemption will be $11,400,000.

The increased exemption is not permanent and it is set to expire on December 31, 2025, returning to the pre-TCJA figure of $5,000,000. While the exemption is set to decrease, Treasury recently clarified that if a taxpayer utilizes his or her increased exemption now, and later dies when the exemption is reduced, that the gifts made during the increased exemption period will not be subject to estate tax. As a result, taxpayers are using the following strategies to ensure utilization of the increased exemption:

  • Irrevocable Trusts: Taxpayers are creating and funding irrevocable trusts for the benefit of their descendants in order to utilize the increased exemption. For example, a taxpayer may settle an irrevocable trust for the benefit of their children and fund the trust with assets up to their remaining exemption amount. This will enable the taxpayer to remove up to a maximum of $11,180,000 from their estate. By making the gift during the increased exemption period, a taxpayer can protect against the potential decrease in the exemption amount starting in 2026. In addition, by making the gift now, a taxpayer removes all future appreciation on the assets from their estate, meaning the appreciation on those assets will pass transfer tax free to their descendants. In certain circumstances, in addition to being able to provide for descendants, taxpayers may also be able to structure the trust to provide for their spouse. Finally, taxpayers may consider utilizing assets that are eligible for valuation discounts, such as interests in a closely held corporation, to fund the irrevocable trust. The utilization of discounts enables taxpayers to further leverage the increased exemption by reducing the gift tax value of the transferred assets.
  • Self-Settled Asset Protection Trusts (APT): Taxpayers are settling irrevocable self-settled asset protection trusts. More than a dozen states permit an APT to be created. The structure of the APT allows a taxpayer to make a completed gift, while retaining the ability to receive income from the trust, as well as protect the trust assets from future creditors. In light of the increase exemption, taxpayers are using this type of trust to remove assets (and appreciation) from their estate while retaining the ability to receive income from the assets if absolutely necessary. This type of trust is not appropriate for taxpayers with existing creditor issues.
  • Forgiveness of Outstanding Loans: As part of a previous estate planning strategy, a taxpayer may have sold an asset to a trust created for the benefit of their descendants. In return for selling the asset to the trust, a taxpayer usually receives a promissory note. In light of the increased exemption, taxpayers may consider forgiving the balance due on any outstanding promissory notes as an easy way to utilize the increased exemption.

As a result of the increased exemption, many taxpayers who previously may have been subject to the estate tax may no longer be subject to the estate tax. This does not mean that planning is no longer relevant for these taxpayers; rather they should carefully consider the impact of income taxes.

  • Incomplete Non-Grantor Trusts (INGs): As a result of a limitation imposed on itemized deductions under the TCJA, taxpayers are now limited to a maximum deduction of $10,000 per year for their state and local income and property taxes. This limitation particularly impacts taxpayers who reside in states with high income taxes. As a result, taxpayers are creating INGs in order to move income-producing assets to a state that (i) imposes no income taxes on a trust or (ii) does not impose income taxes on a nonresident beneficiary of a trust. The most common jurisdictions being Delaware, Nevada and Wyoming, where the fiduciary income tax laws are favorable. In order to be successful, the taxpayer needs to retain control over the trust assets so that the funding of the trust is not considered a completed gift for federal gift tax purposes, while avoiding any power that would result in the taxpayer being considered the grantor for federal income tax purposes. This is usually quite a tightrope to walk, but the creation and structure of INGs has been blessed by the IRS in recent Private Letter Rulings (please note that Private Letter Rulings are not binding precedent).
  • Exercising Powers of Substitution: Often times when an individual creates an irrevocable trust during their lifetime, he or she retains the ability to substitute assets inside of the trust with assets held outside of the trust, so long as the assets are of equivalent value. This "substitution power" is commonly used to obtain grantor trust status which allows the settlor to pay the trust's income tax liability. Taxpayers who fall below the increased exemption amount should monitor and consider substituting low-basis assets inside of a trust (e.g., appreciated stock) for high-basis assets held outside of a trust (e.g., cash) to get a basis "step-up" at death. By engaging in this strategy, taxpayers can ensure that any appreciation on the low-basis assets permanently escapes income taxation at their death.

Following the recent mid-term election, the House of Representatives and the Senate are controlled by different parties, meaning legislative change related to tax reform is unlikely in the next two years. Now is the time to reevaluate your current estate plan and engage in planning prior to 2025.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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