Estate Planning after The Tax Cuts and Jobs Act of 2017

If you have an estate plan already in place or are preparing one this year, are you aware of the impact The Tax Cuts and Jobs Act of 2017—the Act—will have on it? The law signed by President Trump on Dec. 22 reshaped many areas of federal tax law, including the federal estate tax, gift tax and generation-skipping transfer, or GST tax. To understand changes in the law, and how they might affect you, it is helpful to have a basic understanding of how the federal estate tax works. 

The estate tax is applied to a decedent’s gross estate, which is broadly defined to include most of a decedent’s assets valued at the date of the decedent’s death. However, only that portion of the gross estate, less certain deductions, exceeding a threshold amount, known as the applicable exemption amount is subject to estate tax at a rate of 40 percent. In other words, if a decedent dies owning assets worth less than the exemption amount, then no estate tax is owed, but otherwise, the value in excess of the exemption amount is taxed at 40 percent. The tax code allows a similar exemption from gift tax for lifetime gifts and an exemption from GST tax for transfers to those more than one generation younger than the donor. 

In 2000, the exemption amount was $675,000 (a little less than $1 million in 2018 dollars). Over the past 17 years, it has increased significantly, climbing to $5.49 million in 2017, and rendering the estate tax moot for most Americans. Beginning in 2011, the exemption amount became “portable” among married persons, meaning the portion of the exemption amount not used by the first spouse to die can be transferred to a surviving spouse if an estate tax return is filed. Accordingly, a married couple dying in 2017 with total assets valued less than $10.98 million ($5.49 million x 2) would not pay any estate tax. 

For tax years beginning 2018 and ending in 2025, the Act increased the exemption amount from $5.49 million $11.18 million (indexed for inflation). With portability, under the Act, a married couple can now exclude up to $22.36 million in assets from estate tax, gift tax and GST tax. 

In the past, when the exemption amount was lower, estate plans were often designed to exclude property from a taxpayer’s estate so that the asset was not subject to estate tax. However, the effects of death are two-fold in the federal tax code. While death triggers the applicability of the estate tax under Chapter 11 of the tax code, it also creates a tax benefit with regard to income tax under Chapter 1 of the tax code.  

When a taxpayer sells property, the amount received from the sale, less the cost basis of the property, is subject to income tax as a capital gain. Cost basis is generally the amount that the taxpayer originally paid to acquire the property. In other words, when property that has appreciated in value beyond the original cost basis is sold, the appreciation is subject to capital gains tax. The long term capital gain tax rate generally varies between zero and 20 percent.

For purposes of income taxes, at death, the cost basis of assets owned by a decedent is increased to fair market value. This concept is referred to as a “step-up” in cost basis.  As a result, a person inheriting property from a decedent is only subject to capital gains tax on appreciation occurring after the decedent’s death. 

Accordingly, owning appreciated assets at death can reduce capital gains tax. However, as explained above, assets owned by a decedent at death are subject to estate tax if the total value of the decedent’s gross estate, less deductions, exceeds the exemption amount. For high net-worth individuals, the increase in estate tax resulting from owning assets at death will eventually exceed the income tax savings resulting from a step-up in cost basis. 

On the other hand, a taxpayer with assets valued at less than the exemption amount benefits from an estate plan that includes all of those assets in the taxpayer’s estate at death in order to achieve a step-up in cost basis to
fair market value. Doing so reduces the capital-gains tax on appreciated assets that might otherwise be payable by the taxpayer’s heirs and without incurring any estate tax.  

What can you do to make sure your estate plan accomplishes your goals in light of these changes in the law?  The best advice is to meet with an estate planning attorney who can provide recommendations based on your unique circumstances.