Diversified Capital Management

Increased Federal Estate Exclusion

Increased Federal Estate Exclusion

The 2018 tax act temporarily, but dramatically, increased the basic exclusion amount, the amount that can be transferred by an estate with no Federal estate tax liability. The 2019 basic exclusion amount is $11,400,000 per individual, or $22,800,000 for a married couple. This amount is increased by a mandated inflation factor each year, and is scheduled to be reduced by half in 2026.

Historically, our estate tax planning has focused primarily on reducing potential estate taxes by reducing the estate. However, based on changes in both income and estate tax legislation, our focus is shifting to increase estate assets for income tax planning purposes. Assets that pass through an estate receive a step-up in basis, which allows heirs to sell appreciated property that passes through an estate with no income tax. See our blog on basis step-up for more detail. Estate Basis

So now, with less than .5% of estates subject to Federal estate tax, we are looking at several planning items to increase estates. State law should be reviewed to see how this planning will impact State estate taxes.

Below are some of the items we are suggesting people review who fall below the estate tax threshold:

Terminate Annual Exclusion Gifting

One of the more common estate reduction strategies historically is making annual exclusion gifts to reduce the senior generation’s estate. This strategy is now detrimental from an estate tax standpoint. The more assets the decedent holds at death, the more step-up in assets and reduced income tax liability for the heirs.

Gifting to Senior Generation

A strategy that should be considered now is a backwards gift. Instead of moving assets from the senior generation, it may be appropriate to have the younger generation gift assets to an older relative.

Undoing Trusts

A critical planning need is to review every trust that is currently in place. Many testamentary trusts were established with a design to provide income and asset protection to the surviving spouse, but also remove the assets from their taxable estate. This was the most common strategy for estate planning for decades. Most of these bypass trusts will have an opportunity for the trustee to provide the surviving spouse with the principal of the trust. If the principal of the trust is transferred to the spouse, the assets will be included in their taxable estate.

Example
When Jerry passed away, he had an estate valued at $2,500,000. His wife, Janet, had assets in her own name of $2,000,000. As part of Jerry’s will, $1,000,000 was transferred to a bypass trust for his two daughters. The assets in the bypass trust have grown in value to $1,600,000. If the trustee does nothing, on Janet’s demise the two children will receive, as remainder beneficiaries, the $1,600,000 in assets from the bypass trust with a basis of $1,000,000. If the trustee distributes the $1,600,000 to Janet before her demise, the heirs will receive the same assets worth $1,600,000, but with a basis of $1,600,000. This will cost the family $0 in estate taxes and save them approximately $200,000 in income tax on the sale of the inherited investments.

Powers of Appointment

In addition to assets owned outright, a basis step-up is available to any asset includible in the taxable estate of a decedent. Granting a spouse a general power of appointment over property will cause estate inclusion to that spouse, even if that power isn’t exercised. With the increased basic exclusion, it does not matter from an estate tax standpoint if the asset is included in both spouse’s estates, as long as there is $0 estate tax. This allows for a step-up in basis at both deaths.

Exchange Intentionally Grantor Trust Assets

Another common estate planning tool has been the establishment of intentionally defective grantor trusts (IDGT). An IDGT is an irrevocable trust drafted to cause the trust to be disregarded for income tax purposes but be treated as a completed transfer for estate tax purposes. The whole concept of the IDGT was to move assets or asset appreciation out of the taxable estate. These are the exact type of assets that should be includible in the estate to receive a step-up. These entities should be reviewed to maximize income tax opportunities.

Valuation Discounts

The argument is going to be shifting on valuation discounts. Historically the taxpayer would argue for as high of a discount as possible on property includible in the taxable estate. Contracts were designed with provisions to maximize discounts by restricting transfers, right of first refusal, lost voting rights on transfer, etc. The IRS would counter argue that the discount should be limited, and agreements within a family should be disregarded as their principle purpose of the provisions was to support a discount.

All of this planning will not change, as we desire no discount in a non-taxable estate. This may mean undoing some of the contracts we did to support the discount.

Please give us a call to discuss how this planning could be used for your Family, and to go over other planning opportunities related to estate planning with the new exclusion amount.