The new tax law provides opportunities for individuals to pass considerably more wealth on to their loved ones. Beginning in 2018, the federal exemption for gift, estate and generation-skipping transfer taxes is doubled from $5 million to $10 million (adjusted for inflation). For 2018, the inflation-adjusted exemption amount is expected to be $11.18 million. This means, on the federal level, a married couple can potentially leave over $22 million tax-free to their heirs. But, there is a catch.
The new tax law’s increased exemption amount only applies to transfers made from 2018 through 2025. Unless the law is changed or extended, the exemption amount will return to its pre-2018 level beginning in 2026.
The sunsetting of the increased exemption provides a planning dilemma for many people. There is a possibility (albeit slight) that the IRS may try to “claw back” transfers made during this period if the exemption is reduced in 2026. The IRS has been directed to address the possibility of a claw back, but it is uncertain if or when such provisions will be enacted into law.
The key to planning for the new law is to ensure your estate plan is flexible. For example, a formula clause in a married person’s will or revocable trust may cause a credit shelter trust to be funded with the entire increased exemption amount. While this result may provide for the decedent’s children, it may leave the surviving spouse with considerably less assets to live on. Accordingly, all formula clauses should be reviewed to ensure they provide your desired outcome both if the exemption amount stays high and if it is reduced.
Taxpayers should be cautious in assuming this new tax law is carved in stone. A shift in budgetary concerns or which political party has control may affect whether the increased exemption amount even lasts through 2025.
While some people may hope that the increased exemption amount means they no longer need to create an estate plan, the new law should not impact whether you should have a plan in place. The main goal of estate planning has always been to ensure your loved ones are cared for in a manner you agree with after your passing. A thorough estate plan addresses many issues besides taxes, including asset protection from creditors and protecting against spendthrift heirs while still providing for them.
Estate planning may also be used to provide confidentiality. In Pennsylvania, wills are public records once they are probated, which allows any person to obtain a copy. However, if an estate plan utilizes a will that leaves everything to a revocable trust, the details of the revocable trust are not available to the public. A comprehensive estate plan will also include documents that prepare for your potential incapacity, such as a durable power of attorney and health care power of attorney.
Individuals should regularly review their estate plans. When such a big change in tax law occurs, it’s the ideal opportunity to revisit your plan. The Tax Warriors® at Drucker & Scaccetti are skilled at reviewing estate plans and can work with attorneys to provide recommended changes. Call on us to help with your intergenerational wealth planning.