The New Uncertainty in the Estate Tax Law Creates Opportunities for Gifting to Heirs and Charities

Forbes magazine published an article earlier this year entitled: “Trusts In The Age Of Trump: Time To Re-Engineer Your Estate Plan.” One of the most favorable provisions in the new tax law–Tax Cuts and Jobs Act (TCJA)–is the doubling of the number of assets you can pass to heirs estate-tax-free–without using any trusts or advanced planning strategies. TCJA allows the law allows $11.18 million per person to be passed to kids or other noncharitable heirs free of federal gift or estate tax. An unlimited amount of money can be left to spouses—which has been in the law since the 1980’s.

This new increased exemption applies to gifting as well as after death transfers. The Forbes Article rightfully points out that couples, now with a combined exemption of slightly over $22 million, can pass assets onto future generations transfer tax-free and by using dynastic trusts can keep those assets out of the transfer tax system for future generations as well.

Many estate plans have provisions that were appropriate when the exemptions were much lower. An all too common trap is a will or trust that uses a structure tied to a lower amount. While there are many good reasons to continue to use a bypass her credit shelter trust to capture the estate tax exemption of the first spouse to die, such as assuring assets end up with intended beneficiaries without subject the beneficiaries marital or divorce issues or creditor problems, we at Strauss Attorneys have started to utilize more flexible and favorable formulas for creating those trusts (such as an election by the executor or administrator as to where to place assets at the first death) and improving on the income tax results when the surviving spouse dies.

From many of our clients, the focus has shifted from estate tax minimization to making sure their beneficiaries receive the best possible income tax treatment on inherited assets. When a person dies, the tax on built up capital gains in their assets can be avoided because the assets in the person’s estate get a step up in basis to their current value. These assets include not only stocks and bonds that are not held in a retirement account but also real estate and collectibles. The key is to get another step up in basis when a surviving spouse dies so that you get a step up not only at the death of the first spouse but also at the death of the second spouse.

In order to assure the best possible income tax treatment in a revocable trusts, we are recommending that estate plans be reviewed to determine the appropriateness of adding language and provisions to either automatically step up appreciated assets at the second spouse’s death or give a trusted advisor the authority to grant a step up to the surviving spouse. Additionally, the revocable trusts have more compressed income tax brackets then individuals, so you get to the higher brackets faster even though the maximum bracket is the same for individuals trusts. One way to minimize income tax in a trust that is being taxed at a high marginal tax rate is to allow for income to be gifted to charities. Irrevocable trusts are not subject to the standard deduction in order to deduct charitable contributions so having a provision that allows income to be gifted to charity might be beneficial.

Finally, the Forbes article talks about the so-called “mother-in-law trust.” We at Strauss Attorneys are familiar with this technique that allows for a step up in income tax basis when the mother-in-law dies and passes it to beneficiaries. The assets in the mother-in-law trust get a step up in income tax basis because they are technically includable in the mother-in-law’s estate. Even though the assets will be subject to estate tax in the mother-in-law’s estate, there would be no estate tax if kept within the higher exemptions now available to pass assets tax-free. The same technique also works for fathers in law and parents. Bottom line is the desire to avoid capital gains tax when assets are eventually sold.

Now for the bad news. The higher doubled estate tax and gift tax exemptions expire December 31, 2025 unless Congress acts. Congress is supposed to pass regulations on whether using exemptions before 2026 will be grandfathered, but they haven’t even acted on that. Most commentators believe that it is worthwhile reviewing your current estate plans, updating them to provide more flexibility in light of increased exemptions, and possibly utilizing the increased exemptions before they expire. Every new tax law brings opportunities, and this one is no exception.