Annual Estate Planning Law Updates
Annual updates are posted in December or January each year to cover the major legal changes from the previous year. This page provides legal information, not advice. You need to contact your attorney to determine how the laws affect you and if there are any other laws not cited here that may affect your situation.
Significant estate planning developments in 2018
- The historically high increased exemption amounts for gift, estate and generation-skipping transfer taxes is scheduled to increase to $11.4 million on January 1, 2019.
- The IRS proposed rules that will allow taxpayers to take advantage of the historically high exemption amounts for gift, estate and generation-skipping transfer taxes with respect to transfers made on or before December 31, 2025, even if the exemption amounts are subsequently reduced.
- Estate plans that have not yet been reviewed since the Tax Cuts and Jobs Act of 2017 was enacted should be reviewed to determine if there are new planning opportunities of which they can take advantage.
The Tax Cuts and Jobs Act (the Act), which was signed into law on December 22, 2017, continues to provide extraordinary opportunities for our estate planning clients. However, some of the opportunities are temporary. As 2018 comes to an end, clients should consider the following nine things as they wrap up 2018 and begin their planning for 2019.
1. Take Advantage of the Temporary Increases in Exemptions from Gift and Estate Taxes.
Currently, gratuitous transfers of property, whether by lifetime gift or upon death, in excess of the unified gift and estate tax exemption (the “lifetime exemption”) and which are not otherwise exempt from transfer tax are taxed at a federal rate of 40 percent. The Act doubled the lifetime exclusion amount to $10 million, as adjusted for inflation. Beginning January 1, 2019, the already significant $11.18 million lifetime exemption will increase to $11.4 million due to the inflation adjustment. This increase permits individuals who have already used their $11.18 million lifetime exemption to pass on an additional $220,000 in 2019 without incurring a federal gift tax. Individuals who used their lifetime exemption prior to the Act should consider making additional gifts. With proper planning, married couples will be able to transfer up to $22,800,000 of property without incurring a transfer tax.
Clients should consult their advisors regarding which assets to transfer in order to optimize the benefits of any lifetime gifts. For example, it is generally advisable to make gifts of assets with a high tax basis and retain assets that have significantly appreciated. Retaining appreciated assets until death will result in those assets being included in the client’s taxable estate and receiving a step-up in income tax basis. That step-up, in turn, may reduce the income tax that will be due if the assets are sold.
Although the lifetime exclusion is scheduled to increase to increase for inflation through 2025 under the Act, the increase is temporary. Prior to the Act, the lifetime exemption was $5 million, indexed for inflation. Unless new laws are passed, the doubled exemption amount will terminate and the lifetime exemption will revert to the prior $5 million level (adjusted for inflation) on January 1, 2026.
On November 23, 2018, the Internal Revenue Service published proposed regulations which clarify that there will be no “clawback” of gifts made by taxpayers on or before December 31, 2025, regardless of whether the lifetime exemption amount is subsequently decreased. Although the regulations have not yet been finalized, there is a temporary opportunity to transfer significant wealth to future generations without paying Federal estate or gift taxes.
2. Take Advantage of the Temporary Increase in Exemptions from Generation-Skipping Transfer Taxes.
Like the lifetime exemption, the generation-skipping transfer tax (GSTT) exemption amount affecting transfers to grandchildren and more remote generations will increase to $11.4 million per individual or $22.8 million per married couple. However, this opportunity is also scheduled to sunset to pre-2018 levels in 2026.
The Act does not impose any limitation on the duration of a generation-skipping transfer to a trust beyond that imposed by state law. Thus, it is still possible under the Act to create a generation-skipping transfer trust in some states that will continue in perpetuity, and avoid the GSTT on the transferred amount plus appreciation after the date of the transfer.
Clients who have implemented planning techniques to take advantage of the GSTT exemption should ensure that their GSTT exemption is properly allocated by timely filing Form 709 with respect to the transfers.
3. Be Sure to Make Your Annual Gifts.
In 2018 and 2019, individuals may make gifts of up to $15,000 per recipient without triggering the tax. Married couples eligible to split gifts may make gifts of up to $30,000 per recipient. Gifts to a spouse who is a U.S. citizen are not taxed, regardless of the value of the gift. The annual amount which may be given to noncitizen spouses without subjecting the transfers to gift tax has increased to $155,000 for 2019.
4. Consider Interest Rate Sensitive Opportunities.
Each month, the IRS publishes interest rates that taxpayers may use, or in some circumstances must use, in connection with their income or gift tax planning. These rates are called the Applicable Federal Rates (AFR). Since 2012, when the AFR reached an historic low, the rates have been slowly increasing. There are several planning strategies which are advantaged by the still-low interest rates.
Clients who would benefit from planning strategies that use low interest rates should consider implementing those strategies before the AFR increases any further. In addition, clients who implemented such techniques when the AFR was higher than the current AFR should reevaluate their plans to determine if application of the current AFR could enhance the benefits of their plans. For example, clients who sold assets to a grantor trust in exchange for a promissory note prior to 2009, when the AFR used to determine the promissory note’s interest rate may have been higher than the current AFR, or made a loan to a child for a note, should consult with their legal advisors about refinancing the promissory note in order to take advantage of the lower AFR.
5. Take Advantage of Basis Planning.
If a grantor trust owns assets with a low tax basis relative to their current fair market value, clients should consider exchanging those assets for cash or assets with a high tax basis. This type of exchange between an individual and grantor trust is not treated as a sale for income tax purposes, and, consequently, will not trigger an income tax. When the individual dies, under current law, the low basis assets that he or she owns will receive a “step-up” in basis equal to the fair market value of those assets at the time of death. If the assets are then sold, no tax will be owed on the sales proceeds up to the amount of the new “stepped-up” basis.
6. Consider Bunching Charitable Contributions into a Single Year.
The Act allows taxpayers to deduct charitable contributions of cash up to 60 percent of their adjusted gross income—an increase from 50 percent under prior law. Clients should consider accelerating their charitable donations to offset the tax burden created by the reduction in itemized deductions discussed above, possibly through a donor-advised fund. It may be desirable to consolidate planned charitable gifts into a single year instead of making gifts over the course of multiple years.
7. Keep an Eye on State and Local Taxes.
Your Pillsbury Team is closely monitoring developments with respect to the deductibility of state and local taxes. The Act significantly limited deductions for state and local income taxes, sales taxes and property taxes. Both single and joint filers are permitted a maximum itemized deduction of $10,000 for their state and local taxes. This limitation negatively affects taxpayers who reside or work in states with high income tax rates, such as California, Connecticut, New Jersey and New York. These states have been seeking ways to reduce the impact of the loss of this deduction on their residents. Connecticut, Maryland, New York and New Jersey have filed a lawsuit asserting that the cap is unconstitutional.
8. Be Aware of State-Level
A significant number of states impose a form of estate or inheritance tax on their decedents. California continues not to impose an estate tax on its residents. In 2019, the New York State estate tax exclusion is scheduled to increase to $5.74 million for deaths on or after January 1, 2019 and before January 1, 2020. Decedents with dates of death on or after January 1, 2019 will also no longer be required to include the amount of gifts in the calculation of their New York gross estates, regardless of the date they were given.
9. Determine if Old Trusts Would Benefit from Modification.
The concept of trust decanting, or pouring over assets from one trust into a new trust with more favorable terms, has become increasingly popular in recent years. California adopted the Uniform Trust Decanting Act in September 2018, and it will become effective January 1, 2019. The new law permits trustees to modify certain existing irrevocable trusts without court approval or consent of the settlor and beneficiaries.
The Tax Cuts and Jobs Act, providing extraordinary estate planning opportunities, was signed into law by the President on December 22, 2017.
- The new Act allows for a great opportunity to take advantage of increased exemption amounts for gift, estate and generation-skipping transfer taxes starting on January 1, 2018.
- As enacted, the opportunity continues until December 31, 2025, but it can always be modified by subsequent legislation.
- All estate plans should be reviewed in light of the new Act.
The Tax Cuts and Jobs Act, entitled the “Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (the Act), has passed, providing exceptional opportunities for our estate planning clients.
Many notable provisions of the Act become effective on January 1, 2018, and several key provisions sunset on December 31, 2025. We strongly advise clients not to wait for the sunset at the end of 2025 to take advantage of this significant estate planning opportunity, because a change in Congress could bring a sooner end to this opportunity than the sunset. Below, we have provided a preliminary discussion of the Act’s important changes to the tax law that affect our estate planning clients.
Temporarily Increased Exemption from Gift and Estate Taxes
The Act doubles each taxpayer’s exemption from estate and gift tax through 2025, enabling a taxpayer to give away up to $11.2 million (or $22.4 million per married couple; base exemption amount of $10 million, adjusted for inflation since 2011) during life and at death without incurring federal gift or estate tax.
After 2025, the increased exemption amount reverts to the current law that would have provided an exemption in 2018 of approximately $5.6 million per individual and $11.2 million per married couple, indexed for inflation.
The Act continues to permit a “step-up” in basis on assets inherited from a decedent.
Temporarily Increased Exemption from the Generation-Skipping Transfer Tax
Another important aspect of this special opportunity is the expanded generation-skipping transfer tax (GSTT) exemption. Similar to the gift and estate tax exemption, the GSTT exemption amount affecting transfers to grandchildren and more remote generations also doubles in 2018 to $11.2 million per individual or $22.4 million per married couple. This opportunity also has a time limitation because the GSTT exemption amount reverts after 2025 to the current exemption amount (indexed for inflation).
The Act does not impose any limitation on the duration of a generation-skipping transfer trust beyond that imposed by state law. Thus, it is still possible under the Act to create a generation-skipping transfer trust that will continue in perpetuity if the proper state law is applicable.
The Act did not change portability. “Portability” is the ability for a surviving spouse to use the unused gift and estate tax exemption amount of a previously deceased spouse.
New Rules for Charitable Contributions
The Act allows taxpayers to deduct charitable contributions of cash up to 60 percent of their adjusted gross income—an increase of 10 percent from current law.
Changed Tax Brackets and AMT
The Act changed the individual tax brackets. There are still seven brackets, but the top tax rate is 37 percent, which applies to single filers over $500,000 and married couples over $600,000. The personal exemption is eliminated, but the standard deduction is increased to $12,000 for single filers and $24,000 for joint filers.
The individual Alternative Minimum Tax (AMT) remains intact, but the exemption amounts have been temporarily increased to $109,400 for married couples and $70,300 for single filers.
The Act suspends through 2025 a number of existing deductions, including those for moving expenses, alimony, most casualty losses, and all other miscellaneous itemized deductions subject to the 2 percent floor.
The Act reduces the availability of interest deductions in respect of mortgages put in place after December 15, 2017, limiting the deduction to interest on combined principal acquisition indebtedness of up to $750,000 on a principal residence and one other qualified residence. The interest deduction for home equity loans is suspended.
In a development important to our clients in states with high income tax rates, such as California, Connecticut, New Jersey and New York, the Act significantly limits deductions for state and local income taxes, sales taxes and property taxes. Both single and joint filers are permitted a maximum itemized deduction of $10,000 for their state and local taxes.
The Act affects the international tax regime. The Act provides for a transition to a modified territorial international tax system, which exempts from taxation certain foreign source dividends.
Pass-Through Businesses Benefits are Limited
Although the Act alleviates some tax burdens for pass-through business owners to try to match the Act’s benefits for corporations, the benefit is limited. Pass-through business owners may deduct 20 percent of qualified business income, but are subject to a wage limitation that is phased in for joint filers whose income exceeds $315,000 ($157,500 for individual filers). Owners of service businesses are phased out of the benefit entirely when their income exceeds $415,000 for joint filers ($207,500 for individual filers).
Private Equity Tweaked
As seen in the preliminary bills from the House and Senate, the impact on “carried interest” benefits is minimal. Under the Act, to obtain favorable tax treatment for carried interest, the investment must be held at least three years.
529 Plans Expanded
The Act expands the permissible uses of section 529 plans. 529 accounts will continue to be available to pay college tuition, but now may also be used to pay up to $10,000 per year on tuition at elementary and secondary schools.
Opportunities for Estate and Tax Planning:
- Clients should consider additional gifting transactions starting in 2018 to take advantage of the historic doubling of the exemption amount under the Act. This opportunity is set to end after 2025, but that sunset may come sooner with legislation from a new Congress. Connecticut residents should consider the application of the Connecticut gift tax.
- The benefits of funding dynasty trusts that last for generations will be amplified with the increased GSTT exemption amount. Again, there is only a limited time for this historic opportunity to exempt such a large amount of assets for generations. Note that the current opportunity for using the long term GSTT exemption combined with the gift tax exemption offers powerful leveraging of the exemptions and remains available under the Act.
- Business owners should have their estate plans reviewed by our team to see if the Act has affected the tax efficiency of their ownership structure or has created opportunities for the client.
- All clients should have their estate plans reviewed to determine whether the Act has changed the distribution of their estates. Note that the increase in estate tax exemption could alter the wishes of a married couple with respect to the division of an estate between a spouse and a “credit shelter trust.” Similarly, all clients who reside in states with state estate tax should review the impact of the increased federal exemption and their “credit shelter trust” on their state estate tax burden.
- Transfer Taxes. The major changes made in 2010 in the law regarding gift, estate, and generation-skipping transfer (“GST”) taxes (collectively, “transfer taxes”) are now permanent, although the new Congress could amend them.
- Gift Tax. The tax-free “annual exclusion” amount remains $14,000 in 2017. The cumulative lifetime exemption increased from $5,450,000 in 2016 to $5,490,000 in 2017 (inflation adjustment). The tax rate on gifts in excess of $5,490,000 remains at 40%.
- Estate Tax. The estate tax exemption (reduced by certain lifetime gifts) also increased from $5,450,000 in 2016 to $5,490,000 in 2017, and the tax rate on the excess value of an estate also remains at 40%. All of a decedent’s assets (other than “income in respect of a decedent,” such as IRAs and retirement plan benefits), as well as a surviving spouse’s half of any community property assets, will have an income tax basis equal to the fair market value of those assets at the date of death [“stepped-up (or down) basis”]. In this regard, securities brokers still are required to retain basis records and report the income tax basis of securities to the IRS. Accordingly, be sure to advise your broker of your basis in securities received by gift or inheritance. In addition, Executors now must report the basis of inherited assets as shown on the federal estate tax return to the IRS and to the beneficiary of the asset.
- GST Tax. For 2017, the GST tax rate also remains at 40% and the lifetime exemption also has increased (inflation adjustment) from $5,450,000 in 2016 to $5,490,000 in 2017. Section 5 on page 5 includes more information about the GST tax.
- Portability of Estate Tax Exemption. The “portability” rules provide for the transfer of a deceased spouse’s unused estate tax exemption (“deceased spousal unused exclusion amount” or “DSUEA”) to a surviving spouse (without inflation adjustments). Thus, if a 2017 decedent’s taxable estate is not more than $5,490,000, the DSUEA can be used by the surviving spouse with respect to both gift taxes and estate taxes (but not GST taxes). Portability is not available if either spouse is a nonresident alien. Portability may allow some couples to forgo a more complex estate plan while still taking advantage of both spouses’ transfer tax exemptions. Portability must be irrevocably elected on a timely filed (including extensions) estate tax return, even if a return is not otherwise required to be filed.
- A typical estate plan for a married couple generally has provided for the establishment of two (or three) trusts at the death of the first spouse: A “Survivor’s Trust;” a “Residual (or “Exemption” or “Bypass” or “Credit Shelter”) Trust;” and possibly a “Marital Trust.” One of the reasons for the Residual Trust is to use the deceased spouse’s estate tax exemption to the fullest extent possible. Under the new portability law, however, if one spouse dies and leaves assets to persons (other than the surviving spouse and charity) in an aggregate amount less than the basic exclusion amount ($5,490,000 in 2017), the surviving spouse may be able to use the DSUEA as well as the surviving spouse’s own exemption.
- This portability provision may eliminate the need to create a “Residual Trust” at the first spouse’s death. For example, if this year the first spouse to die leaves all of his or her assets to the surviving spouse, no part of the deceased spouse’s exemption is used because of the marital deduction available for assets passing to a surviving spouse at the first spouse’s death. Unless the surviving spouse remarries and survives his or her new spouse, he or she will have an aggregate exemption of (i) $5,490,000 (DSUEA) and (ii) his or her own inflation-adjusted $5,490,000 exemption ($10,980,000 total in 2017). Similarly, if in 2017 the first spouse to die leaves $1,000,000 to his or her children, the surviving spouse will have an aggregate exemption of $9,980,000 (use of the remaining $4,490,000 DSUEA in addition to his or her own inflation-adjusted $5,490,000 exemption).
- In many cases, however, we will advise our clients to continue to use a Residual Trust as part of their estate plans for both tax and non-tax reasons.
- Tax reasons include the following: (i) The DSUEA is not indexed for inflation; (ii) eliminating estate tax on any appreciation of Residual Trust assets at the surviving spouse’s death, regardless of the value of the surviving spouse’s assets; (iii) allowing for an allocation of the deceased spouse’s GST exemption to the Residual Trust1; (iv) the surviving spouse could remarry and be limited to using the unused exemption of his or her second predeceased spouse if any (a DSUEA thus may inhibit remarriage); and (v) an estate tax return must be filed timely to qualify for portability.
- Non-tax reasons include the following: (i) Limiting (or eliminating) the ability of the surviving spouse to direct the disposition of the deceased spouse’s assets on the surviving spouse’s death; (ii) restricting the surviving spouse’s right to use principal (perhaps only for health, support, and maintenance); (iii) providing creditor protection (creditors generally cannot reach the assets in an irrevocable trust established by another person); and (iv) providing professional management if desired.
- Residual Trust disadvantages include the following: (i) Annual costs for the preparation of Residual Trust income tax returns and maintaining separate records for the Residual Trust; (ii) the possible loss of a further stepped-up basis on the surviving spouse’s death; (iii) lack of surviving spouse ability to change the estate plan to adapt to changed circumstances, unless as is often the case the surviving spouse has a limited power to change the Residual Trust distribution provisions; (iv) lack of ability to offset capital gains and losses realized by the surviving spouse and the Residual Trust; (v) Residual Trust assets generally cannot be used to implement further estate planning techniques; (vi) the surviving spouse cannot use the $250,000 exclusion from capital gain upon the sale of a residence held in the Residual Trust; and (vii) possible need to accelerate taxable distributions from retirement accounts.
- Two Planning Tips. If the reasons for establishing a Residual Trust are not significant, but you nevertheless want to provide for the possible establishment of a Residual Trust in case your spouse later decides that it is advisable to do so, your estate plan can provide for distribution of your estate to your spouse, but include a provision that would allow your surviving spouse to “disclaim” all or a portion of his or her inheritance and arrange for the disclaimed assets to be allocated to a Residual Trust (“Disclaimer Trust”). The surviving spouse could make his or her decision to disclaim during the nine-month period following the first spouse’s death. The only difference between a Disclaimer Trust and a Residual Trust established by the first spouse is that the surviving spouse could not have the power to provide for distribution of the assets of a Disclaimer Trust in a manner different from the first spouse’s distribution plan.
- A qualified Marital Trust enables a deceased spouse to maintain control over the distribution of the trust assets upon the death of the surviving spouse, can preserve the deceased spouse’s unused GST exemption through a “reverse QTIP election,” and provides a greater degree of creditor protection than would be afforded by an outright bequest to a surviving spouse. Using a Marital Trust to accomplish these objectives (rather than a Residual Trust) may allow the trust assets to receive a step-up in basis upon the death of the surviving spouse and, in some cases, may postpone payment of state level estate taxes until the death of the surviving spouse. In addition, the surviving spouse may wish to elect portability and subsequently use the deceased spouse’s remaining estate and gift tax exemption (DSUEA) to make lifetime gifts tax-free. The IRS has eliminated the uncertainty that existed in 2016 regarding the validity of a qualified Marital Trust (QTIP) election made solely to allow for the use of portability.
- Income Tax Changes. The following is a brief summary of the 2017 inflation adjustments to the federal income tax rates:
- The highest tax rate (39.6%) is imposed on incomes in excess of $470,700 (was $466,950) (joint return), $444,550 (was $441,000) (head of household), and $418,400 (was $415,050) (single). These brackets will continue to be adjusted for inflation annually;
- The social security tax remains 6.2%;
- The alternative minimum tax (“AMT”) exemption amounts are increased to $84,500 (was $83,800) (joint return) and $54,300 (was $53,900) (single);
- The maximum tax rates for most long-term capital gains and dividends remain 20%; and
- The itemized deduction and personal exemption “phase-outs” adjusted gross income thresholds are increased to $313,800 (was $311,300) (joint return), $287,650 (was $285,350) (head of household), and $261,500 (was $259,400) (single), which thresholds will continue to be adjusted for inflation annually. These “stealth tax” provisions effectively increase marginal tax rates for those affected.
- In addition, a 3.8% “Medicare” tax is still imposed on investment income (including capital gains) of “high-earning” taxpayers, and a 0.9% Medicare tax is still imposed on employment income earned by those taxpayers.
- The temporary California income tax increase in 2012 (retroactively to January 1, 2012), for “high-income” taxpayers, which was scheduled to terminate in 2019, was continued temporarily through December 1, 2031, (Proposition 55). The 2016 brackets for joint returns were as follows2:
- 10.3% on income between $537,500 and $644,998;
- 11.3% on income between $644,998 and $1,074,996;
- 12.3% on income over $1,074,996; and
- An additional 1% “millionaire’s tax” on income over $1,000,000.
- Taxes can be extended or modified as the legislature desires with a two-thirds majority vote (no taxpayer vote is required).
- Revocable Trust. The revocable trust is a valuable estate planning technique for both single and married clients, used primarily to avoid the inconvenience and extra costs of a probate administration of an estate upon death (multiple probate administrations would be required if you own property in other states). The same estate tax savings techniques available by Will can be employed via the revocable living trust. Many of the post-death income tax advantages previously available to probate estates have been eliminated, thus making the revocable trust even more attractive for wealthier clients. We usually suggest that our California clients use revocable trusts rather than Wills as their primary estate planning vehicles.
- An Israeli income tax may apply to a revocable trust (including those created prior to 2017), of which at least one beneficiary is an Israeli resident, even if there are no assets in Israel, no trustee in Israel, and the trustor is not an Israeli resident.
- Annual Gift Program. A lifetime gift-giving program could reduce overall transfer tax costs considerably. By receiving lifetime gifts, donees will benefit from all future appreciation of and income generated by the transferred property free of transfer taxes. This year, every individual may transfer cash or other property worth $14,000 (or $28,000 for married couples) to each of as many donees as the donor selects without incurring any gift or later estate tax. An inflation adjustment applies when that adjustment would increase the annual exclusion amount by $1,000 (e.g., to $14,000 in 2013 and probably to $15,000 in 2018). Donors may make these gifts (known as “annual exclusion” gifts) outright or via custodianships or trusts, although careful planning is needed if trusts are to be used. For example, it is very important to assure that any trust for a grandchild contains special provisions so that gifts made to that trust are exempt from the GST tax (discussed in section 5 on page 5). In addition, no gift taxes are imposed if you pay a donee’s tuition or medical expenses (payments must be made directly to the school or health- care provider), and you may prepay tuition under certain circumstances.
- Even if a gift is not “tax-free” as described above, if your aggregate gifts do not exceed the $5,490,000 lifetime gift tax exemption amount (or $10,980,000 for married couples), no gift tax will be payable at the time of the gift. Taxable gifts in excess of the $5,490,000 lifetime exemption will accelerate transfer tax payment, but an overall tax savings may result because your gift tax dollars generally will not be subject to estate taxes at death. Paying gift taxes now, however, may result in an unnecessary tax payment if estate taxes would not be payable at death under new legislation; the possibility of estate tax repeal should be considered. Certain valuation advantages (such as “minority” discounts) that might be unavailable at death often are possible under current law in connection with lifetime gifts (e.g., see section 13 on page 7). Finally, although interest rates rose slightly in January, the relatively low interest rates still in effect make this a very good time to loan funds to younger generations, and may make certain types of gifts via trust particularly attractive. Many people expect rates for short-term and mid-term loans to rise significantly in 2017.
- Life Insurance. Life insurance proceeds are generally exempt from income tax. In addition, all estate tax on life insurance proceeds may be avoided on the death of the insured through proper planning: Insurance proceeds can be available free of estate tax to the surviving spouse, but by designating other family members or a trust for their benefit as owners and beneficiaries, estate taxes can be avoided in both spouses’ estates. “Joint life” (or “survivorship” or “second to die”) policies make life insurance planning affordable for many more people. You should consider the ownership and beneficiary designations for any newly acquired life insurance carefully before the policy is purchased. You also should review the ownership and beneficiary designations of your existing policies; your revocable living trust or Will does not generally control distribution of life insurance proceeds. “Split-dollar” life insurance plans now are subject to much more stringent rules; we suggest that you review with an insurance professional or with us any “split-dollar” life insurance programs in which you currently participate or in which you contemplate participating. Finally, recent economic activity may have caused your life insurance policies to experience financial problems; you may wish to contact your insurance professional to discuss the current status of your policies.
- GST Tax. The GST tax generally imposes an additional transfer tax (at the 40% estate tax rate) on property transferred to grandchildren and other younger beneficiaries by lifetime gift or at death, and whether outright or via trust. Certain techniques are available to avoid or substantially reduce this GST tax. One technique involves making “tax-free” gifts as described in section 3 on page 4 via an “annual exclusion” gift program to grandchildren (either outright or via trust) and by paying a grandchild’s tuition and medical expenses (remember, direct payments to the school or healthcare provider are required). Another technique involves use of your lifetime GST exemption to establish a “dynasty” trust (which can invest in life insurance policies or other property) to enable a substantial amount of property to pass to grandchildren, great-grandchildren, and later generations free of any estate or GST tax. The GST exemption for 2017 is the same as the unified $5,490,000 estate and gift tax exemptions. Whereas use of the gift and estate tax “exemptions” is automatic, use of the GST exemption is elective. In view of the voluntary GST exemption allocation rules, we generally recommend that clients who make gifts to trusts from which a grandchild or other younger beneficiary may receive distributions file gift tax returns (even if not required) in order to specifically elect whether to allocate or not allocate GST exemption to those trusts.
- Marital Deduction; Noncitizen Spouse. The vast majority of married couples combine the estate tax “exemption” granted to each person with the unlimited marital deduction to assure that no estate taxes are payable until the death of the surviving spouse. The unlimited marital deduction generally is available for gifts and bequests to spouses; those gifts and bequests can be outright transfers or can be made via trusts (although not all types of trusts will qualify for the marital deduction). Severe restrictions, however, are imposed on the ability to defer estate taxes if the surviving spouse is not a United States citizen (the surviving spouse’s residence is not a factor). Under these rules, property passing to a noncitizen surviving spouse must be held in a special type of trust (a “qualified domestic trust”) in order to qualify for the marital deduction. In addition, although gift taxes on gifts to noncitizen spouses generally cannot be deferred via the marital deduction, in 2017 you may make “annual exclusion” gifts (discussed in section 3 on page 4) of a maximum of $149,000 (rather than $14,000) to your noncitizen spouse (subject to annual inflation adjustments). As discussed in section 1-D on page 1, portability is not available if either spouse is a nonresident alien. You should review your estate plan now if either spouse is not a U.S. citizen.
- Estate Planning for Nonresident Aliens. The estate of a nonresident alien (“NRA”) (a noncitizen who is not a U.S. resident) has only a $60,000 (not $5,490,000) estate tax exemption available (and no gift tax exemption). U.S. donees of gifts from NRAs or foreign estates in excess of $100,000 [or $15,797 in 2017 (inflation adjusted) from a foreign corporation or partnership] must report these gifts to the IRS on Form 3520. Several interesting planning opportunities may exist for an NRA. An NRA may avoid transfer taxes completely by structuring his or her holdings so that no U.S. “situs” assets are owned directly (for example, U.S. “situs” assets may be held by a wholly-owned foreign corporation, although U.S. real estate presents special income tax issues). If your spouse is not a U.S. citizen, you may wish to defer estate taxes by use of a “qualified domestic trust” (discussed in section 6 above). Lifetime gifts by an NRA of U.S. “situs” intangible personal property (such as stock or partnership interests) are not subject to U.S. gift taxes, even though these items would be subject to U.S. estate taxes if owned by the NRA at death. An NRA also may wish to establish a trust to hold property for U.S. resident children or other family members to provide them with tax-free income and arrange for the trust property to pass to other family members free of transfer taxes.
- A U.S. taxpayer who expatriates (“covered expatriate”) can be subject to severe tax penalties unless that taxpayer has a net worth of less than $2,000,000 and average annual income of not more than $162,000 (subject to annual inflation adjustments). The tax penalties can be deferred on an asset-by-asset basis if an election is made (interest and security are required). In addition, a 40% transfer tax is imposed on the receipt by U.S. taxpayers of any amounts in excess of $14,000 (adjusted for inflation) from a “covered expatriate.” The IRS issued Proposed Regulations in September 2015 concerning the donee’s duty to report receipts from a “covered expatriate” on new IRS Form 708 (to be released after Final Regulations are issued).
- Community Property v. Joint Tenancy. For income tax purposes, both “halves” of appreciated community property receive a “step-up” in basis upon the death of either spouse. Because only one-half of the basis of property held in joint tenancy receives a basis “step-up” at the death of the first spouse, we generally recommend that legal title to appreciated assets owned jointly by spouses and not held in a revocable living trust be held as “community property” rather than as “joint tenants.” California now recognizes “community property with right of survivorship” as a form of legal title for real estate.
- Charitable Tax Planning. There are several techniques available to transfer significant wealth to intended beneficiaries in a tax-favored manner and at the same time benefit charity. This is particularly true in connection with a sale of highly appreciated assets; a charitable remainder trust can be used to your advantage in these circumstances. You also may be able to arrange to receive a lifetime annuity in exchange for cash or appreciated property, or even for agreeing to transfer your residence to a charity at your death (or at the death of the surviving spouse). You also may be able to transfer property to your descendants without (or with reduced) transfer taxes by establishing a charitable lead trust. The income tax benefits of donating partial interests in tangible personal property items (such as works of art) are currently restricted. The popular “Charitable IRA Rollover” rules were made permanent in 2015; these rules are discussed in paragraph 11 below. Wealthier taxpayers may be interested in a private foundation or a donor-advised fund established at a public charity, such as a community foundation. The IRS has developed two webpages that may be of interest to these taxpayers: “Life Cycle of a Private Foundation” deals with private foundations, and “Life Cycle of a Public Charity” deals with public charities.
- “Buy-Sell” Agreements/Options. A “Buy-Sell” or option agreement (whereby a family member or business associate has the obligation or option to acquire assets at an established price) can be used to your advantage to restrict ownership of a business, to establish the value of an asset for estate tax purposes, and to provide a market for the asset to allow owners to plan for liquidity. This estate planning device is subject to restrictions, but some of these restrictions do not apply to agreements made before October 9, 1990. You therefore should be very careful if you wish to modify “Buy-Sell” or option agreements made prior to October 9, 1990. Employer-owned life insurance generally now is subjected to income taxation, although insurance used to fund a Buy-Sell Agreement is exempt from income taxation, provided that certain written notice and consent requirements are met in advance.
- Employee Benefit Plans and IRAs. Assets in pension and profit-sharing plans, IRAs, and other retirement plans (other than Roth plans) can be subject to severe taxes at death. You should review your plan benefits to determine whether you can avoid or postpone these taxes and whether your plan benefits are coordinated with your estate plan; your revocable living trust or Will generally does not control disposition of these benefits. Plan proceeds still can be the most advantageous to use for charitable gifts at death, including transfers to charitable remainder trusts and to establish charitable gift annuities. The “Charitable IRA Rollover” provisions were made permanent in 2015, so taxpayers who attain age 70½ can direct a maximum of $100,000 to charity from an IRA (only); the payment will not be included in the taxpayer’s income for the year, but it nevertheless will count against the taxpayer’s “minimum required distribution” for the year. No charitable contribution deduction will be allowed, but most taxpayers nevertheless would benefit by using this technique as opposed to withdrawing funds from an IRA (taxable) and contributing those funds to charity (deductible, but subject to certain limitations).
- Subchapter “S” Corporations. The use of Subchapter “S” corporations has become somewhat less popular because of the increased use of limited liability companies (“LLCs”). Care must be taken, however, with respect to existing Subchapter “S” corporations. For example, upon the death of a Subchapter “S” corporation shareholder, Subchapter “S” corporation status can be lost unless the decedent’s shares pass to a qualified shareholder in a timely manner. All Subchapter “S” corporation shareholders therefore should assure that their estate plans allow for the continuation of Subchapter “S” corporation status. Subchapter “S” corporations also might be used to reduce payroll taxes imposed on their owner-employees.
- Family Limited Partnerships and Limited Liability Companies. A “family limited partnership” (“FLP”) or “family limited liability company” (“FLLC”) can be an excellent estate planning vehicle for clients who own valuable assets. A FLP or FLLC can be advantageous if a family member encounters creditor problems in the future. Gifts of FLP or FLLC membership interests to your beneficiaries or to trusts for their benefit can qualify for the gift tax “annual exclusion” (discussed in section 3 on page 4) if properly drafted, and the value of those gifts can reflect the “discounts” available for minority and nonmarketable interests. “Discounted” values also can be used in connection with sales to desired limited partners or LLC members, including family members or trusts for their benefit. Some recent IRS challenges to these entities have been successful, however, so all administrative and operational details must be respected; some recent court decisions have focused on the actual organizational and operational aspects of the family entities. In addition, the IRS has issued Proposed Regulations to address some of the perceived abuses in valuing minority interests in family businesses. These regulations are not (and may never become) final, and their scope is uncertain. The tax benefits anticipated at the time of the formation of the entity should be available at the donor’s death if the entity is organized for a significant non-tax business purpose and operated strictly in accordance with the provisions of the governing instrument and applicable state law, the donor has retained enough assets outside the entity to satisfy the donor’s personal financial needs, and the donor is not a general partner or LLC manager. We continue to urge all clients who have implemented FLPs or FLLCs to review those entities now and to consider making any contemplated gifts of interest in family entities before the Proposed Regulations are adopted.
- Durable Powers. It has become more important to plan for the risk of lifetime incapacity. A Durable Power of Attorney can provide for lifetime asset management, especially if your estate plan does not include a revocable living trust. An Advance Healthcare Directive permits you to designate someone to make healthcare decisions on your behalf if you become unable to do so, and also can be used to make known your desires that artificial life-prolonging measures be or not be employed on your behalf. Appropriate healthcare documents for your children (both minors and adults) also should be completed. A Durable Power of Attorney for Healthcare signed prior to 1992 probably is ineffective in California today. The California Secretary of State has established an Advance Healthcare Directive Registry, and will issue an identification card to each registered person and respond to inquiries by healthcare providers. In addition, you should consider executing an appropriate Authorization for use and disclosure of health information that otherwise would be protected and thus unavailable under the federal Health Insurance Portability and Accountability Act (“HIPAA”).
- Same-sex Marriages; Registered Domestic Partnerships. The United States Supreme Court has held that same-sex couples have a constitutional right to marry. This decision may significantly impact an estate plan and may have important tax (as well as marital dissolution and property settlement) consequences. Below is a list of some of those consequences, many of which may be retroactive (same-sex married couples may amend previously filed income and transfer tax returns for tax years for which the statute of limitations has not run).
- The availability of the marital deduction for both gift and estate taxes, including the ability to transmute separate property of one spouse to community property (or vice versa) without negative gift tax consequences.
- The treatment of retirement benefits and the availability of the spousal rollover IRA.
- The opportunity to file one joint income tax return or two separate returns as married filing separately;
- Both spouses may use the gift, estate, and GST tax exemptions, tax advantages of “split gifts” for gift tax purposes, and the ability to use portability.
- Increased healthcare access and rights.
- Increased opportunities for international estate planning and citizenship.
- California’s Domestic Partners Rights and Obligations Act of 2003 applies to all unmarried same-sex couples and to unmarried opposite-sex couples if at least one opposite-sex partner is at least 62 years old. An expanded version of the law in 2005 extended the rights of a Registered Domestic Partner (“RDP”) in areas ranging from health- care coverage and parental status to property ownership, legal obligations, and funeral arrangements. A transfer of California realty between the RDPs (during life or at death) does not constitute a “change of ownership” for California property tax reassessment purposes. RDPs are treated as having community property after the date of registration (retroactive for RDPs registering prior to January 1, 2005; the IRS recognizes community property laws as they apply to RDPs). But RDPs still are not “married” for federal tax purposes. All RDPs must file California income tax returns on the same basis as married persons (“joint” or “married filing separately”), but same-sex RDPs must continue to file their federal tax returns as unmarried individuals, thereby greatly complicating their tax return preparation. RDBs who prefer not to undertake all of the commitments can terminate their registrations. The procedure for terminating a Registered Domestic Partnership is the same as the procedure for obtaining a divorce (with a limited exception). It may be advisable to execute a written “Preregistration” Agreement (similar to a “Prenuptial” Agreement) before registering as Domestic Partners.
- Digital Assets. This is an often overlooked category of assets that you should consider when creating an estate plan. Many people have many digital accounts, and those accounts may be inaccessible when the person becomes incapacitated or dies. Automatic payments from bank accounts would continue until the bank is notified.
- California adopted the Revised Fiduciary Access to Digital Assets Act effective January 1, 2017, which will determine who if anyone can access your digital assets. You may use an “online tool” (such as Google’s “Inactive Account Manager”), or you may provide for your digital assets in your estate planning documents, or the “terms of service” agreement will govern the disposition of your digital assets.
- Deposit Insurance. The FDIC bank deposit insurance limit is $250,000 per account. Generally, all retirement accounts of a single “participant” at a particular bank are insured up to $250,000. All accounts held by a revocable trust are insured on a “per settlor per beneficiary” basis. For example, a single revocable trust established by a married couple that provides that, on the death of the first spouse, the assets will remain in the trust for the benefit of the surviving spouse for life, and that on the death of the surviving spouse, the assets will be divided into equal shares for their three children, will be insured while both spouses are living for $1,500,000 at each bank in which the trust maintains accounts (husband is treated as having three $250,000 beneficiaries, and wife is treated as having three $250,000 beneficiaries). This rule will apply regardless of the relationship between the trust creators and the beneficiaries; previous law provided for this protection only to certain close family members.
- Foreign Asset Reporting. The Treasury Department is actively pursuing taxpayers who fail to report their foreign assets, including foreign bank and securities accounts and foreign fund accounts maintained outside the U.S. on IRS Form 8938 as required by the Foreign Account Tax Compliance Act (“FATCA”). Filing this Form 8938 does not relieve U.S. taxpayers (including nonresident U.S. citizens and dual citizenship individuals) from the separate obligation to file a Report of Foreign and Financial Accounts (“FBAR”) (FinCEN Report 114, replacing Form TD F 90-22.1) that must be received by the Treasury Department by April 15 each year (subject to a six-month extension) to report an interest in, or a signature authority over, any financial account in a foreign country if the aggregate value of those accounts exceeds $10,000 at any time during the calendar year. The FBAR must be filed electronically. These two forms must be filed even if the accounts or assets earned no income. IRS Form 8938 must be filed with a U.S. resident’s income tax return if total foreign financial assets aggregate $50,000 at year-end or $75,000 at any time during the year (single or married filing separately) or $100,000 at year-end or $150,000 at any time during the year (joint return). Severe penalties may be imposed for failure to comply with either of these filing requirements. On June 18, 2014, the IRS announced a modified offshore voluntary disclosure program, effective July 1, 2014, that includes significant changes providing new options for U.S. taxpayers who have not yet complied with the reporting requirements. The IRS also announced modifications to its “Streamlined Compliance Procedures,” a program designed for taxpayers whose failures to report their foreign accounts were negligent or not willful. Finally, FATCA, which generally became effective on July 1, 2014, requires foreign banks to report the identities of their U.S. depositors to the IRS.