Taxation - Income, Estate, & Gift
By David Toups, JD, MBA, CFA®, CFP®, CTFA
The Tax Cuts and Jobs Act of 2017 (TCJA) doubled the lifetime federal estate and gift tax exclusion amounts; however, that law includes an automatic sunset provision and, absent changes in the law before then, the increased benefits provided by that law end at the conclusion of 2025.
Now that 2020 is here, that sunset is just five years away. Certain gifts, such as life insurance, once transferred, are counted and dragged back into an estate if the transfer occurred within three years from the grantor’s date of death (called a look-back period).
Once look-back provisions are considered into the planning equation, the window to act to obtain the maximum benefit from the TCJA's increased exclusion amounts further narrows. With potential political environment changes coming later this year with the U.S. national elections determining the control of the Senate, House of Representatives, and the presidency, the possibility exists that these limits could be changed after the outcome of the 2020 election cycle.
If the political winds shift later this year, the mad rush to capitalize on the existing benefits will be intense and may leave many without the planning time to fully use the tax cuts. Therefore, planning to use and benefit from the increased TCJA's gift and estate tax exclusion amounts should be undertaken sooner rather than later.
This year, each person may gift or leave $11.58 million to loved ones, and a married couple could potentially gift or leave $23.16 million. The existing law provides that at the conclusion of 2025, the federal exclusion amount reverts back to $5 million indexed for inflation. So, a married couple with assets, including life insurance policies on their lives, could potentially lose out on the ability to transfer in excess of $10 million without federal estate tax if they do not take advantage of the increased limits, which are set to expire. The federal estate tax rate is 40% and, once expired, the tax due on the extra amount would exceed $4 million. When the increased limits expire, they are no longer available for use.
State Estate Tax Opportunity
For people owning property in states with a state-imposed estate tax, the current increased federal gift limits may offer a unique opportunity to avoid a state's estate tax. Most states with an estate tax do not also have a gift tax; however, many states have a look-back period to include gifts made several years prior to death. For individuals subject to state estate taxes, failing to use their available lifetime federal gift tax exclusion amount subjects their estate at death to the full brunt of the state's estate taxation structure.
Irrevocable trusts are often used to transfer assets out of a person's estate. Once transferred, those assets may grow and not face estate tax again until the assets pay out to a beneficiary who then claims them as part of their estate. For the most part, if a grantor of an irrevocable trust retains an interest in the trust, those assets would still be included in their estate (certain trust provisions exist that may allow a grantor to retain specific rights without triggering this unfortunate result). However, for married couples, one spouse may gift assets to an irrevocable trust for the other spouse as the beneficiary. As long as the trust limits the spouse's access to the assets to an acceptable ascertainable standard, such as for the health, education, maintenance, and support of the spouse, those assets would not be includable in the beneficiary spouse's estate even though the assets would be still be available for that spouse's benefit within the specified limitations provided during their lifetime. Additionally, as long as duplicate reciprocal irrevocable trusts are avoided, each spouse may gift assets to an irrevocable trust for the benefit of the other spouse. This potential strategy serves as a powerful estate planning tool to capitalize on the increased lifetime gift tax exclusion amounts, while permitting a spouse to benefit from the gifted assets.
For entrepreneurs who own their own business or business entities, corporate structuring strategies exist that may permit the company to separate the ownership characteristics of the firm, which would be included in an estate for estate tax purposes, from the control of the firm. By having an irrevocable trust own the bulk of the outstanding non-voting shares or interests, which would constitute most of the company's value, outside of an entrepreneur's estate, the estate tax liability exposure due to the company's valuation would be greatly diminished. Yet, the entrepreneur's ability to control the cash flow stream from the company (such as the ability to determine salaries, bonuses, or distributions) with the retained controlling interest (voting shares) provides for his or her needs but allows for the growth and increased value to accumulate outside of his or her estate.
Multiple strategies exist that may assist individuals and couples to reduce or negate estate and gift taxes aimed at diligent savers, investors, and entrepreneurs. The TCJA's increased exclusion amounts greatly assist in providing some relief; however, discussing, assessing, determining, and implementing these strategies takes some time. Although it may seem like years remain to take advantage of these increased limits, in reality, the opportunity window is closing rather rapidly once look-back provisions, planning, and implementation timeframes are considered.
If reducing the share of your estate given to the government could be a concern, speak with your trusted advisors to discuss using the TCJA's increased exclusion amounts before they expire.
David R. Toups, JD, MBA, CFA®, CFP®, CTFA,
joined The Nautilus Group in 2016 after more than 14 years in the private practice of law, focused in estate, trust, guardianship, and business planning and litigation. Prior to practicing law, he managed money professionally as an investment portfolio manager for several national corporate fiduciaries. He earned his BBA in marketing from Texas A&M; his MBA, with a finance emphasis, from Sam Houston State; and his JD, with honors, from South Texas College of Law. David also served in the U.S. Marine Corps as an artillery and infantry officer.
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