For all the complexities and uncertainties created by the Tax Cuts and Jobs Act signed into law in December 2017, one area of planning for high net worth clients is relatively straightforward, although it comes with a big looming cliff in the future. The straightforward part is the doubling of the exemption from wealth transfer taxes. Each brand of tax affecting transfers of wealth, including the estate tax, the gift tax, and the generation skipping transfer tax, is suddenly easier to avoid, or at least minimize. On its face, it is quite simple - you could pass on to heirs roughly $5.5 million tax free before the change, now you can transfer a little over $11 million. Double those numbers if you implement your estate planning with a spouse.
However, the simplicity of this change masks more involved questions - how soon should you transfer ownership and control of assets to use that additional exemption, and how should you do so? As to the timing, the doubled exemption expires out of the law in the year 2026, when the exemption will revert back to 2017 levels (with some inflation adjustments that would added in). As a result, the higher capacity for tax free gifting will be lost absent further law changes passed by Congress.
In and of itself, that does not seem to be much of an immediate problem; eight years is ample time to implement thoughtful estate planning transfers. What is hard to predict is whether current law will hold up in the shifting political landscape. It is not a stretch to assume that a Democratic majority in Congress would reverse the estate and gift exemption increases, or more, with any new tax legislation, and of course assuming a complicit or deal-minded President signs off.
Then again, the Democrats controlled the White House and Congress in 2009 and 2010, and the repeal of the Bush era tax cuts from 2001 was still not accelerated. Under any circumstance, passing tax law changes is not easy work. This leads to the early thought that inertia will win, and all of the tax reform changes that are scheduled to expire in 2026, including the estate and gift tax exemptions, will expire at that time.
So much for predicting elected officials. Whether you choose to give attention to the issue now depends in large part on the threshold matter of whether you are likely to experience wealth levels that get taxed, either exceeding the new $11 million exemption ($22 million for a married couple),or the rollback in 2026 to half that amount. The vast majority of Americans do not have this problem. But prudent management of wealth can change circumstances.
Think of the simple rule of 72s - a 9% annual return (in excess of spending) will double your wealth in eight years (a point in time when the estate tax exemption will shrink by half). Such investment performance is difficult to achieve but not impossible, and it merely demonstrates that personal net worth can change very much in such a time frame. As well, it is a simple fact that if investment performance and other income exceeds household spending, net worth will grow. For high net worth families, this is quite common. So even if the higher tax exemptions stay in place until 2026, implementing planning now can redirect this eight years of investment growth to occur outside your taxable estate.
Let's assume for the moment that the case is made to engage now in some wealth transfers to lower estate tax exposure. How do you go about implementing that planning? Predictably, this is determined case by case. A big issue for you could be that making large gifts now precedes the certainty of who should receive the gifts, under what condition they will have access to ownership and control of the transferred assets, and what to do if you later change your mind on these decisions. Further, will the transferred wealth be needed by you in the future for costs of living or investment opportunities? Can you still retain an income stream or at least access to periodic distributions from the property that was transferred? Can you continue to control how the transferred assets are used, spent, distributed and invested?
Even with all the changes caused by the 2017 tax reform, the techniques for both making gifts during life and passing wealth at death have remained in place. The toolbox is full. In most every situation, there will be a combination of actions that can serve to satisfy all of the wealth transfer concerns mentioned above. Particularly for married couples, it is readily doable to fund trusts for the benefit of heirs and have a spouse remain a beneficiary of that trust, and also possess decision making authority to react and make changes later due to positive and negative developments involving the trust beneficiaries. Even for unmarried wealthy persons, options exist to engage in estate planning that makes use of current tax exemptions without losing all economic benefit and control, although there may be a few more hurdles to clear in achieving a tax-effective plan.
Income tax burdens can also be factored into the plan. If the trust is designed correctly, paying income taxes related to income inside a trust can function as a tax-free gift, and the trust assets then grow on a pre-tax basis. What a thrill it is to pay income taxes on trust investments of which you are not the beneficiary! You might feel a pinch writing the checks, but it is sound estate planning to do so.
Retaining some control over transferred wealth can also be achieved without the use of irrevocable trusts. It might be preferable to make effective use of corporations, LLCs and partnerships when family assets include operating businesses and private ventures that benefit from your continued management control.
Consider it a call to arms. For most high net worth families, there is little reason to suspend estate planning activity because of the increased estate and gift tax exemptions. Instead, consider the law change an opportunity to engage in even more tax-free effective planning. The presence of uncertainty with future personal cash flow needs, with family member maturity and other dynamics, even with broad economic concerns such as a looming recession, can be accounted for in plans that make use of temporary estate, gift and GST tax exemptions.
Keep in mind this is not locker room or water cooler talk. What works for one family may be very inappropriate for another. There is no one magic plan, but there are many good potential solutions.