GOODBYE TO THE ESTATE TAX? A DEMISE GREATLY EXAGGERATED
On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act. In the press, aside from its clear impact on income taxes, this legislation was hailed as the "death of the death tax." According to one government estimate, of the approximate 2,800,000 individuals passing away in the U.S. each year, only 1,800 estates will now incur Federal estate tax in 2018. While this appears to be good news, it is critical to understand the differences between Federal and New York estate tax laws, as well as appreciate the importance of estate planning in general. Failure to review your estate plan in light of these changes may actually result in greater taxes and greater headaches!
The new Federal legislation provides for the Federal estate, gift, and GST tax exemptions to increase to $11,180,000 per person and $22,360,000 per married couple (adjusted for inflation). This more than doubles the pre-2018 exemption amounts. The tax rate remains at 40%. Additional highlights and factors to consider:
*This part of the legislation will sunset on January 1, 2026, at which point the Federal exemption amounts will revert to pre-2018 figures, or $5,000,000 per person and $10,000,000 per married couple (adjusted for inflation). Without further legislation between now and 2026, the 2026 exemption amounts will be approximately $6,000,000 per person and $12,000,000 per married couple after adjusting for inflation. Therefore, the next 8 years provide a window to engage in estate and gift tax planning while the exemptions are much higher. This presents planning opportunities that may not be around forever.
*This new legislation applies to Federal law. States also have estate tax laws. Approximately 1/3 of states in the U.S. still have some form of state estate or inheritance tax. In New York, the estate tax exemption amount is $5,250,000 per person until 2019 when it will be increased slightly to adjust for inflation. The New York tax rate is 10-16%. There is no combined estate tax exemption for married couples (known as "portability") in New York.
*The Federal legislation retains the concept of portability. In other words, an imbalanced allocation of assets between two spouses does not result in disaster for estate tax planning purposes on the Federal level. If Spouse 1 (Sally) dies with a $4,000,000 estate, and leaves her entire estate to Spouse 2 (Pat), who subsequently dies with a $20,000,000 estate in 2022, there is no Federal estate tax due because of the ability to combine the exemptions. This assumes customary tax filings were made on Sally's death to preserve portability.
*New York estate tax law does not recognize portability. If Sally dies with $1,000,000, and Pat subsequently dies with $8,000,000, New York estate tax will be due on Pat's death. Why? There is no ability to combine the New York exemptions of $5,250,000 per spouse to equal a total of $10,500,000 per married couple in this example. Instead, there will be nearly $800,000 of New York estate tax owed on Pat's death. With careful estate tax planning during lifetime, Sally and Pat can greatly reduce, if not completely eliminate, that New York estate tax bill due on death.
*For individuals with "formula clause Wills" that fund Trusts under their Wills with an amount equal to the Federal estate tax exemption, this is likely problematic for several reasons. First, if the Will was executed in the late 1990s when the exemption was $600,000 per person, and the intent was to bequeath the first $600,000 in a Trust for a spouse and children, and leave the remaining bulk of the estate to the spouse outright, the new Federal estate tax laws will change that structure significantly. In some cases, the entire estate may pass into a Trust on the first spouse's death, with no assets left outright to the surviving spouse. That is unlikely to reflect the individuals' original intent, and it also undermines the ability of the beneficiaries to receive assets with a stepped-up cost basis on the second spouse's death.
Similarly, if Spouse 1 dies with an estate in excess of the New York exemption amount, and his Will is a "formula clause Will" that funds a bypass Trust with the Federal exemption amount at the time of his death, that will create unintended New York estate taxes on Spouse 1's death. This New York estate tax bill could be in excess of $1,000,000!
*Aside from estate tax considerations, the importance of estate planning remains paramount. Special needs planning, divorces, second marriages, blended families, planning for young children/grandchildren, charitable planning, families with stepchildren and/or stepgrandchildren, estranged family members, etc. These situations are becoming more of the norm than the exception. Relying on New York's laws of intestacy (the laws that apply if you pass away without a Will) or remaining complacent with outdated Wills is a recipe for disaster. The new Federal estate tax laws do not rectify these concerns; in many ways, they make it even more important to review and update your estate plan to account for these changes.
