Please note: this article is more than one year old. The views of our team may have changed since it was published, and the data on which it was based may have been revised.
The Tax Cuts and Jobs Act of 2017 has created some significant new opportunities for US taxpayers looking to pass wealth to their heirs more efficiently.
At the end of 2017, major tax legislation was enacted in the United States. Informally known as the 'Tax Cuts and Jobs Act,' this expansive new law affects most taxpayers, including businesses, both large and small, and individuals. Although the business provisions are generally permanent, the provisions affecting individuals are mostly temporary, and run from 2018 through 2025.
In terms of estate planning, these temporary provisions are intended to allow wealthy individuals to pass more to their heirs.
Through 2025, you can now protect over $11 million from gift, estate and generation-skipping transfer taxes, or over $22 million if you’re married (these numbers will continue to increase through 2025, after which – barring Congressional action – the exclusion reverts to $5 million, indexed for inflation). This basic doubling of the 'exclusion amount,' which is $11.18 million in 2018 (or $22.36 million if you’re married), gives you an opportunity to benefit your heirs.
Here are a few common strategies that could help you take advantage of this opportunity:
Make additional gifts. If you have already used your prior $5+ million exclusion ($10+ million if you’re married), you can now make additional gifts without incurring gift tax. You could, for example, give more to an existing trust for your children and grandchildren that you perhaps created under favorable Delaware law – a so-called 'dynasty trust' that can last for multiple generations without additional transfer tax – or you could simply give more outright to your children or grandchildren.
Spousal lifetime access trust. This new $11+ million exclusion could also be the impetus for you to start making gifts. You could use your increased exclusion to create a trust for your children and grandchildren (similar to the trust described above). Although you must part with the assets you give to the trust, you can still access them indirectly if your spouse is an additional trust beneficiary (this works as long as your spouse is alive or you haven’t divorced). Your spouse’s interest in the trust makes it what’s known as a 'grantor trust' – meaning that because you are required to pay the trust’s income taxes, you are effectively making additional gifts to the trust and its beneficiaries, without triggering gift tax.
Sale to 'Defective' Grantor Trust. Suppose that you have assets that generate substantial income or could appreciate significantly, such as a new business venture or property that has temporarily declined in value. The increased exclusion again gives you an opportunity to pass that potential appreciation gift-tax efficiently to your heirs. One way to do this is by selling these assets to a 'defective' grantor trust – a trust that you 'own' for income tax but not estate tax purposes (that’s what makes it 'defective'). In this scenario, you create a trust for children and grandchildren, and fund it with approximately 10% of the property you’re going to sell to the trust. Once you’ve completed the sale, you take back an interest-bearing note. Assuming the assets you sold to the trust outperform the note’s interest rate, the appreciation passes to the trust without gift tax; because of the trust’s 'defective' structure, there are no income tax consequences to the transaction.
Increased returns with life insurance. Life insurance can indirectly help pay estate taxes if your taxable estate is well in excess of your exclusion amount or your estate’s assets are illiquid and cannot be readily converted into cash (such as real estate, art or closely held businesses). Typically, to insulate the insurance proceeds from estate tax at your death, a trust owns the insurance – yet the challenge of funding an 'insurance trust' so that it can afford to purchase substantial insurance can be daunting. The larger exclusion simplifies this funding and reduces the potential gift-tax complications. Also, if a trust you’ve created already has substantial assets because of a successful 'sale' (see above), the trust can purchase life insurance on you (and your spouse), thereby significantly increasing the trust’s value once you both have died, when estate taxes are usually payable.
To sum up. Although the increased exclusion – $11.18 million in 2018 (or $22.36 million if you’re married) – is temporary, it gives you an opportunity to benefit your heirs even more, including with some of the options mentioned above.
Blanche Lark Christerson is a Managing Director for Wealth Planning in the New York office of Deutsche Bank Wealth Management.