Gallet Dreyer & Berkey, LLP | Is Estate Planning Still Necessary Under the New Tax Law?
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Is Estate Planning Still Necessary Under the New Tax Law?

7/11/18 | By: David N. Milner, Esq. | GDB 2018 Summer Newsletter
Before answering the question, first some background: 
 
Our system of estate and gift tax can best be viewed as a tax on the right to transfer assets to someone other than one’s spouse, typically to someone in the next or a more remote generation.  Assets transferred to one’s spouse, assuming the spouse is a U.S. citizen, are not subject to the tax. 


“Life-Time Exemption” vs. “Life-Time Credit” 

As part of the changes that were made to the Internal Revenue Code in December 2017, Congress doubled what is referred to as the “life-time exemption,” the amount that can be transferred by gift while alive or upon death without paying gift or estate tax.  Beginning January 1, 2026, unless changed by future legislation, the law will revert to what it had been prior to the change.  Had the change not been made, the exemption would have been $5,600,000 in 2018.  The actual exemption in 2018 is $11,180,000. If married, any portion of the exemption that is not used by the estate of the first spouse to die is available for use by the surviving spouse. 
 
While referred to as an exemption, there is no place on either a gift tax return or an estate tax return to reflect the available “exemption.” Rather, each individual has available a lifetime credit to be used to offset the gift tax that is due on any taxable gifts made while alive with any unused portion of the credit available to offset the estate tax that is due on their taxable estate.  For 2018, the available credit is $4,417,800 which is equal to the tax on taxable transfers of $11,180,000.  If the taxable transfer exceeds the amount of the credit, the excess is subject to tax at a rate of 40%.
 

Why is This Distinction Important?

 Assume a situation where the husband owns real property or other assets which are expected to significantly appreciate in value.  At the time of the husband’s death these assets are valued at $15,000,000.  If the husband’s will simply left all of his assets to his spouse, there would be no estate tax payable because transfers to one’s spouse are not taxable.  If these assets doubled in value between the time of the husband’s death and the spouse’s death, the couple’s children would be faced with an estate liability of approximately $3,000,000, if the second death occurred prior to January 1, 2026.  This estate tax liability could have been largely avoided through proper planning.  If the second death occurred after December 31, 2025, when the lifetime exemption will revert to what it been prior to the change, the estate tax liability would be $9,400,000. 
 
What should have been done?  The husband’s will should have provided that following his death a portion of his assets equal to the available “exemption” should be held in trust for the benefit of his wife during her lifetime and that following her death the assets be held for the benefit of his children or distributed to them.  This is often referred to as a credit shelter trust.  Provided the wife does not have the ability to direct the manner in which the trust’s income and assets are distributed, the transfer of the husband’s assets to the trust will be subject to estate tax.  However, the estate tax liability would be offset by the available credit.  The balance of the husband’s assets can either be distributed to the spouse or held in a separate trust for her benefit that qualifies for the marital deduction.  To the extent the assets held by the marital trust are not distributed to the surviving spouse during her lifetime, they will be included in the surviving spouse’s taxable estate.
 
Why is this better than simply transferring the assets to the surviving spouse?  Since the assets transferred to the credit shelter trust will not be included in the surviving spouse’s taxable estate, the children would receive the appreciated assets free of estate tax.
 

State Estate Tax

Those taxpayers living in states which impose an estate tax but do not follow the federal estate tax structure may be faced with other issues that need to be addressed as part of the overall estate planning process.  Not doing so may result in their families being faced with an estate tax burden that could have been avoided.


Gifts 

Care should be exercised before making lifetime gifts of assets that either have appreciated or are expected to appreciate following the transfer.  While the making of a gift will reduce the taxable estate of the donor (at the cost of reducing the lifetime exemption available to shield assets upon death)  for income tax purposes, gain is computed by comparing the proceeds received from the sale of assets that have been acquired by gift to the donor’s tax basis.  Losses are computed by comparing the fair market value of the asset at the time of the gift to the proceeds - essentially, the worst of both worlds.  If the assets are transferred upon death, heirs will compute gain or loss using the fair market value of the asset at the time of death
 
To answer the question – Yes, planning remains necessary and will continue to be important as our tax laws evolve. 



FURTHER INFORMATION ON THE NEW TAX LAW CAN BE FOUND IN OUR PAST ARTICLES:

Year End Tax Planning Concepts

Tax Reform 2017