The Holidays are over, for now and so are estate and gift taxes, for now.
The New Year brings in a significant increase in the estate, gift and generation-skipping tax exclusion amount. For 2018, that exclusion amount will be approximately $11,200,000 per person. For those who die before 2026, that increase may completely insulate their estate from federal estate tax.
The increased exclusion amount for estate and gift tax should increase each year for inflation adjustments; however, it is slated to revert to 2018 original amounts after January 1, 2026. (the original exclusion for 2017 was $5,490,000. It was expected to increase to $5,600,000 for 2018 under the prior tax law).
For those whose estates exceed $5,600,000, and who are fortunate enough to live past January 1, 2026, the change in the exclusion amount may not reduce their estate tax unless they take advantage of gifting for the next eight years.
For example, John Smith’s total assets are approximately $12,000,000. He has already gifted $5,000,000 to his children through prior taxable gifts. He can now gift an additional $6,200,000 to them, federally, tax free. If he lives past 2025, presumably, assuming no growth, his estate, subject to estate tax, may only be $800,000.
It is unclear how the IRS will treat the Deceased Spouse’s Unused Exemption (DSUE)
The DSUE is the unused exemption of a previously deceased spouse which is carried over to the surviving spouse. If the first spouse dies before 2026, presumably, any unused exemption of that first spouse will be carried over to the surviving spouse at the full amount of the new increased exclusion amount. (i.e. remaining amount of the $11,200,000). However, we must wait for IRS regulations for further guidance on this.
Don’t forget state estate taxes!
New York’s exemption amount is tied into the 2010 federal exemption amount of $5,000,000.New York does not currently have a gift tax. Its estate tax calculation includes gifts made within three prior years of death and before January 1, 2019. Assuming the taxpayer lives more than three years, making a taxable gift in 2018, utilizing the new federal exclusions through gifting, may not have a detrimental effect in NY.
Connecticut’s exemption is currently $2,600,000—should you decide to take advantage of the temporary increase in the federal exemption through gifting, as a Connecticut resident you will incur Connecticut state gift tax.
Although New Jersey has repealed its estate tax, the New Jersey Inheritance Tax has remained unchanged. The NJ Inheritance Tax is a “beneficiary” tax and is based on who specifically receives a decedent’s asset and how much each beneficiary receives. The New Jersey Inheritance Tax imposes a graduated tax ranging from 11% to 16% on the transfer of real and personal property with an aggregate value of $500 or more to certain beneficiaries. Surviving spouses and lineal descendants are exempt beneficiaries.
The new federal tax law does not eliminate the “step up” in basis at death. Therefore, the recipient’s (heir’s) basis for any asset includible in someone’s estate is the value of that asset as of the date of death (or alternate value if elected on the estate tax return). For example, Mary died owning a home she had purchased in 1977 for $50,000. When she died, the fair market value of the home was $1,000,000. The house was included in her taxable estate. Her children sold the home after her death for $1,200,000. Their taxable gain is only $200,000.
There is a delicate balance for those individuals whose estate falls between $5,600,000 and $11,200,000 and who are elderly or in poor health. Should they gift assets to their children now, so that they utilize the new higher exemptions, or should they wait to allow the assets to be stepped up at death in case they die before January 1, 2026? Can they afford to give up the cash flow their assets provide? Those in this situation may consider a seven year Grantor Retained Annuity Trust (GRAT). A transfer to a GRAT is a discounted completed gift. However, if the donor does not survive the seven year GRAT term, the asset would be pulled back into their taxable estate. At the end of seven years, the asset is fully transferred and out of their estate. GRAT’s provide for an annuity payment to the transferor. A seven year GRAT may be a good solution for those in this situation.
How about those trusts already in existence for taxpayers whose estates are lower than the $11,200,000 and are expected to die prior to 2026? These trusts should be carefully reviewed to ascertain the possibility of decanting or revoking in order to allow for step up in the taxpayer’s estate.
Will the increase in federal exclusions cause the death of the Trust? Trusts are still extremely beneficial as a protection from creditors and in the case of divorce for family members. So for those who are not concerned with estate and gift tax under the new tax law, it would be remiss to not consider trusts for these reasons.
IRC Section 1031: Like Kind Exchanges
The above file will assist in calculating basis and exchange figures.
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