Gift, estate and generation-skipping transfer tax (GST) exemptions have doubled as a result of the Federal Tax Cut and Jobs Act, raising them to historic highs. The exemptions, which are all linked in a unified estate and gift tax, had been scheduled to increase to $5.6 million per person in 2018, but they were modified to reach the current level of $11.2 million per person, or $22.4 million per couple. The inflation-adjusted exemption for 2019 is $11.4 million per person or $22.8 million per couple.
In the article “Updating estate plan could save heirs in taxes,” the Atlanta Business Chronicle asks why this matters to an individual or couple whose net worth is nowhere near these levels.
When the most that could be transferred to heirs was under a million dollars, everyone worried about the estate tax. Since the estate tax was so much higher than the capital gains tax, it was never considered a big deal if a person paid the capital gains tax on selling, because it was less costly than paying the estate tax.
Now with the new exemption, trying to move assets out of estates and into trusts may not be the best solution to preserve wealth and minimize taxation.
In the past, a trust would be created, and the maximum amount of funds placed into the trust for use when the grantor (the person who created the trust) died. The goal was to provide income for the spouse until the spouse’s death, at which point the money bypassed the estate and went directly to the beneficiaries, who would pay income tax on the funds.
If a person owned $10,000 worth of stock at their death and the trust required it to be placed into a bypass trust instead of transferring it to the spouse, the heirs would pay taxes on gains upon the sale of stock. In a case where the stock held in the bypass trust increased to $100,000, then $90,000 of that would be considered taxable gain. If, instead, the stock was transferred to the surviving spouse and it was sold upon the spouse’s death, that stock would receive a stepped-up basis of $100,000 and there would be no income tax on the sale of the stock.
Note that the law creating the present $11.4 million limit is currently set to end at the end of 2025 when the tax exemption will return to $5 million (adjusted for inflation).
Another aspect of estate tax planning relates to the source and account types of the inheritance. For instance, heirs who receive money from Individual Retirement Accounts (IRAs) have to pay taxes when they withdraw funds from the account. IRA money is not taxed when it goes into the account, but the growth is taxed when the money is taken out.
As an alternative, IRAs could be converted to Roth IRAs, although they would be taxed immediately on conversion. If the Roth IRA is held for five years, funds withdrawn are tax-free and can be taken out whenever the owner wishes.
However, because current exemption amounts may not be available after 2025, or if further changes to tax laws are made, another strategy for individuals who wish to make significant lifetime gifts is to make those gifts with the current high levels. Because of the way the transfer tax systems interact, those lifetime gifts will not be taxed at death if the total of taxable gifts is less than the exemption amount in the year the gift is made.
Some experts advise that wealth be distributed between tax-deferred accounts, like 401(k)s, after-tax money, like the Roth IRA and taxable accounts, which include brokerage accounts. The goal is to be able to respond when changes are made to the tax code.
Reference: Atlanta Business Chronicle (May 31, 2019) “Updating estate plan could save heirs in taxes”