When the Tax Cuts and Jobs Act first passed, it left many of us going into the new year with little knowledge about the details. It has been picked apart by experts now and a clearer picture is starting to form. Some of the bigger changes are on the income tax side, providing corporations and individuals with potentially lower income taxes. To be noted is that they left the rates on estates and trusts almost identical to the previous high level. This disparity will make people rethink some year-to-year decisions to reinvest or distribute income from ongoing trusts and estates.
However, substantial updates are seen on the estate and gift tax side, where the individual lifetime exemption has been doubled. This means fewer people than ever will pay estate or gift tax. These numbers were set at $5 million per individual or $10 million for a couple, and are now doubled to $10 million and $20 million respectively. With inflation included, these will be $11.2 million per individual and $22.4 million per married couple that may pass estate or gift tax free in 2018. Above those amounts, however, there is still a hefty tax on anything passed-on or gifted.
For better or worse, much of this new tax bill has a “sunset provision.” This is included due to the law being passed under a special congressional rule. Many of these rules, including the doubled lifetime gift and estate tax exemption, will go back to old numbers in the year 2025 unless Congress reaffirms the bill. Due to the current popularity of the new tax laws, it is also possible that Congress make change things in the years before 2025. With that in mind, anyone with their ear to the floor needs to know both how to maximize the use of the current rules as well as know when and how things may need updating later.
We have both reviewed the rules ourselves and have consumed a dozen white-papers and seminars on the subject, and the following is our early take on how the tax laws effect Californians in the following total net worth categories:
$0-$150,000: Planning in this bracket was not changed by the new laws. In California, if your net worth is below $150,000 and real property (like a house) is less than $50,000, then your estate may pass with the use of just a Will and a summary probate without the need for court supervision. This value includes your house regardless of the mortgage; so $900,000 mortgage on a $1,000,000 house means your net worth includes the whole $1,000,000. The focus of planning at this level is making sure you cut red tape in advance of an emergency or long-term inability to act for yourself. Luckily, a collection of key documents, which we call a comprehensive estate plan, can help make sure everything is handled both before and after you are gone.
$150,000-$5 million: Again, very little changed for this bracket, but there are still red flags to be wary of. Californians worth over $150,000 or who own at least $50,000 in real property are required to go through a court supervised probate, even if they have a Will. Additionally, anything you own at death passes on to your loved ones with the federal capital gains taxes erased (known as stepped-up capital gains basis). The simplest way to avoid the court probate while still erasing the capital gains is with a revocable trust, known sometimes as a living trust. Living trust-based estate plans are all of the documents of a comprehensive estate plan, but everything is pointed towards a trust as the managing document. Trust-based plans are the bread and butter of estate planning in California due to the abnormally high probate costs. This means most firms (including us!) have found ways of making a trust-based estate plan easy to create and manage. Thus, Californians in this bracket are best served with simple trust-based estate plans.
Depending on your personal wishes, the focus of your plan is probably more about providing for your family and friends. Among the popular ways of ensuring protection for married couples is with marital trust planning. Older forms of this focused on estate taxes and often included language requiring the funding of a trust that is no longer a good idea due to the high income tax rates and lack of capital gains stepped-up basis for assets in that trust. Our firm currently uses a more contemporary option that guarantees some assets will be held separately after the first spouses passes, but also lets the surviving spouse make sure the type of trust is the right one for tax reasons.
There are also ways of providing for children and other loved ones without giving an immediate gift of cash. One of the more popular is by making sure IRAs are inherited rather than cashed out with the use of a Retirement Plan Trust. Another is to provide gifts after death in long-term trusts with a special trustee named to prevent the trust assets from going to the beneficiary’s creditors or ex-spouses.
$5 million-$25 million: this is the bracket where estate taxes may have previously affected you, but now you no longer have to worry (at least for the time being). Unfortunately, this means any estate plan already in place needs to be reviewed. Many popular planning techniques from a few years ago will now be costly for you and good for the IRS. Fortunately, cutting edge attorneys and accountants have been testing the waters over the past decade to see what works to help provide flexibility. We currently offer a couple options that can be used in varying ways to plan around different taxes, all of which can be built in to your plan now so fewer revisions are needed in the future. Californians with net worth in this range absolutely should seek advice to make sure their estate is planned correctly for the current rules and possible future situations. As with the above, now that the tax rules are simpler the goal may be to provide the gifts to your loved ones the way you want.
$25 million and beyond: This group is who we can reasonably say will pay estate and/or gift tax. This is the historically high watermark under a unique political climate, which leads experts to think this is as high as it goes. Anyone in this category should consider taking advantage now. If you have not yet done any planning, now is a great time to put something in place. If you have done planning, you should review it and see which parts still make sense. Some popular planning techniques should be updated to consider the new rules. One example would be TCLATs (Testamentary Charitable Lead Annuity Trust) built into revocable living trusts should have the new estate tax numbers incorporated so money doesn’t go to charity that otherwise could be going to your family tax free. Another example would be revising the size of life insurance policies taken out to cover expected taxes after death. While not useless, some larger policies may benefit from being reduced or strategically repurposed for other reasons. And while not directly related to the present tax bill, the withdrawal of proposed 2704 regulations by the IRS means there can still be a benefit to splitting ownership with your loved ones during your life. These techniques are not for everyone, but where they make sense big tax savings can be had.
And so now the collective professional tax world sits back off the edge of our seats and learn forward to finally get some work done. We know the rules for now, and we know how to assemble things to be adaptable moving forward. There has never been a better time to double check with all your tax professionals that things are set up and working correctly for you. And don’t forget, once you are done dealing with your income taxes, you should also talk to us to make sure you estate is handled too!