Estates, Trusts And Tax Reform – New Legacy Planning Perspectives

Legacy planning and estate planning intersect. The success of both depends on your assets and the ability to manage your affairs in the most tax-efficient manner.

Under Tax Reform, the federal estate and gift tax exemption has been doubled to an estimated $11.2 million per individual. If married, and you elect portability, the exemption doubles to $22.4 million (amounts to be annually adjusted for inflation through 2025). So right about now you might be thinking, “…..why do I have to worry about estate planning?” For 3 reasons:

Generally speaking, creating a legacy plan involves a transfer of assets, be it to a trust or some other entity, and this usually comes with tax consequences. With the newly increased gift tax exemption, and the simultaneous doubling of the generation-skipping transfer (GST) tax exemption, an historical high value of assets can be transferred tax free, and sheltered from estate tax in the future. There is now a unique opportunity to gift assets to an estate tax-proof trust so that there will be no federal or state estate taxed owed at death.

Here’s some things to consider:

Gift Tax – You can give one individual $15,000 per annum. If married, you and your spouse can give that same individual a total of $30,000. Anything over that requires the filing of a gift tax return, and the amounts over which you gift are deducted from the estate tax unified exemption. (The gift and estate tax exemptions remain unified so any use of the gift tax exemption during the taxpayer’s lifetime would decrease the estate tax exemption available at death.) If you go over this unified lifetime credit then you have to pay a gift tax of 40%.

You can wait until death or consider gifting appreciated property like securities now. Think twice before you put a home, car or boat, or any other assets in the name of your beneficiaries before you die, this would be considered a gift, and a gift tax return has to be filed.

State Tax – Federal tax reform does not necessarily impact your state’s estate tax. States vary widely in whether and how they impose a state estate tax, and the exemption thresholds are often lower than the federal ones. New York, New Jersey and Connecticut all have very different gift and estate tax rules. Clients should check with their Fuoco Group tax planning professionals as tax strategies will differ.

For example, in 2018 New Jersey’s estate tax was eliminated, so it generally does not matter whether you give away dollars during life or at death. It still has an inheritance tax that applies to transfers made to recipients other than your spouse, descendants or parents.

For New Yorkers, the federal exemption amount is more than double the New York exemption amount. The absence of a New York gift tax, combined with an increase in the federal exemption provides an opportunity to give more away during life in order to reduce state estate taxes at death. Those with an estate close to the New York exemption amount may wish to consider gifting continuously to keep the value of their estate below the exemption amount.

If you reside in a state that imposes a state estate tax, it is crucial that your estate plan addresses this. Tax reform severely limits the SALT deduction.

Lifetime Gifts – Unlike assets transferred at death, lifetime gifts aren’t entitled to a step-up in tax basis. This can create an unexpected income tax liability for the recipient if they sell a gifted asset.

The tax basis of an asset included in an estate generally receives a step-up to the asset’s fair market value at death. Conversely, the tax basis of an asset gifted during life is generally the carryover original purchase price. Be sure to weigh the potential estate tax savings against the potential income tax costs to the recipient.

Gifts of Low Basis Assets – When low basis assets like a home are to be sold shortly after a death, there could now be situations where an individual would keep the asset as part of their estate. This might also be the case with a depreciable asset like rental real estate.

529 and ABLE Plans – These plans permit tax-free withdrawals for qualified educational expenses, but also offer estate planning benefits. Contributions to a 529 plan are removed from an individual’s estate and it is permissible to “bunch” up to five years’ worth of annual gift tax exclusions into one year, without triggering gift or GST taxes or using any of their exemptions.

Irrevocable Trusts – If leaving money or assets to a young child or young adult, consider an irrevocable trust. Once the asset is placed into the irrevocable trust, it will remove the asset from your estate, and protect it against creditors. In addition, you can stipulate what the beneficiaries can do with the assets, at what age they can use the assets, even put a drug and alcohol provision into the trust document.

A trust that worked fine when first established may no longer achieve its original goals since the tax laws changed. There are options to modify the trust, often “decanting” is used. Other remedies may be available, through court proceedings, and you may be able to ask a court to rewrite a trust’s terms to conform with the grantor’s intent. The rules regarding modification of irrevocable trusts are complex and vary dramatically from state to state. And there are risks associated with revising or moving a trust, including uncertainty over how the IRS will view the changes.

Dynasty Trusts – These are irrevocable trusts for high net worth individuals that allow substantial amounts of wealth to grow and compound free of federal gift, estate, and GST (generation-skipping transfer) taxes, providing greater wealth for future generations. Avoiding the GST tax is critical. By allocating your GST tax exemption to your trust contributions, you ensure that any future distributions or other transfers of trust assets to your grandchildren or subsequent generations will avoid GST taxes.

Revocable Trusts – Put in place when one is alive, these are usually needed more for life planning, than tax or estate planning. A revocable trust can be of great benefit when a person is quickly becoming incapacitated due to age or dementia. A properly funded revocable trust can help make sure assets are distributed more quickly, bills are paid promptly and continuously, and avoid the need for a probate court proceeding after death that can take time and keep money from being immediately available. Assets in a revocable trust can be a house, property, or bank and investment accounts. When choosing the trustee, make sure they know how to invest!

When trust property is allocated upon the death of the grantor, consider the use of a disclaimer trust or a trust that can elect to be treated as a QTIP trust in whole or in part, to provide greater estate tax and income tax planning flexibility.

Tax returns for a revocable trust must be filed annually to the Internal Revenue Service. The fund’s assets, at the owner’s death, are subject to any applicable estate tax.

Grantor Retained Annuity Trust – One of the most popular and tax advantageous ways to pass a business on to a loved one is through a grantor retained annuity trust or a GRAT. The owner of the business forms an irrevocable trust and transfers their shares of stock if a corporation, or membership units if an LLC, to the trust. The trust would have a trustee (other than the grantor) to protect the assets from creditors and to remove the assets from the taxable estate, if it exists.

The trust would have a term of ten to twenty years. The ownership vehicle would be placed in the trust at a value determined by the grantor. The trust would then pay the grantor an annuity until the end of the trust term. When the trust ends, the ownership of the business would pass to the beneficiaries.

Unfortunately, the annuity amount is taxable to the grantor, and if the grantor dies while the GRAT is in effect, the assets are removed from the trust and added back to the estate, and could be taxable if the grantor is subject to the estate tax.

There is another way to pass the business to the beneficiaries that is a little more complicated, but protects the assets, and the owner retains control of the business. In this scenario, the profit of the business is used to pay the grantor for the assets, and it is more tax friendly than a GRAT.

The grantor forms an irrevocable grantor trust. Most family businesses are set up as S-Corporations in which you can only have one class of stock: common stock. The stock is split into voting and non-voting shares, making 99% of the shares non-voting. Transfer those shares to the trust at whatever amount the grantor determines, and the beneficiaries are the ones inheriting the stock. The 1% of stock which is voting shares would remain with the grantor. This will pass the majority of the business to the beneficiaries, and the owner of the business keeps control of the business.

The grantor is a passive owner, not required to pay themselves reasonable compensation, but they can take distributions from the S-Corp until such a time as they are paid for the business and relinquish their stock. The shares in the trust are then distributed to the beneficiaries, the business is then removed and passed to the intended beneficiaries. Check with our Business Exit Planning strategists for more information: http://www.fuoco.com/services/exit-planning.

Qualified Terminable Interest Property (QTIP) Trust – A QTIP trust provides your spouse with income for life while preserving the trust principal for your children. What are the estate tax advantages? Unlike most other trusts, a QTIP trust is eligible for the unlimited marital deduction and allows you to transfer any amount of property to your spouse — either during your life or at death — free of gift and estate taxes.

Ordinarily, to qualify for the marital deduction, you must transfer property to your spouse outright or through a trust in which your spouse’s interest cannot terminate for any reason. A QTIP trust allows you to provide your spouse with a “terminable interest” in the trust while still qualifying for the marital deduction. The assets will be included in your spouse’s taxable estate.

Other Items Of Note Related To Tax Reform: