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Estate Tax Reform: Top 5 Takeaways

Top 5

Last week I summarized the 2018 rates and exemptions for gift, estates and trusts. Compared to the major tax code reforms to personal and business taxation, the estate tax changes appear relatively straightforward.

The estate tax was not repealed, but the unified Federal gift, estate and generation-skipping transfer tax exemptions more than doubled overnight from $5.49 million in 2017 to $11.2 million in 2018. That doubled exemption will remain inflation-indexed and in force until the doubling “sunsets” in 2026, at which time the exemption will revert to $5 million inflation-indexed from 2011. But simple changes often have important implications.

Here are my top 5 Illinois estate planning implications to consider:

1. Mind the (Illinois Estate Tax) Gap

While the Federal estate tax exemption is doubling, the Illinois estate tax exemption is not! The Illinois estate tax exemption remains fixed at $4 million, is not indexed for inflation, and is not portable between spouses. That $11 million estate that will result in $0 Federal estate tax in 2018 triggers a $1,058,681 estate tax bill for estates of Illinois residents. For those who might be domicile-shopping, ACTEC provides a nice 50-state estate chart here. Aside from moving, trust planning and gifting can help to mitigate Illinois estate taxes.

2. Review Formula-Based Trusts

There are some potential issues lurking with older marital tax-planning trusts (think pre-2005 and especially the 80’s and 90’s oldies). One is the Illinois estate tax gap noted above. Formulas in older trusts are often tied only to the federal estate tax exemption without regard to the Illinois gap. The result could be an “overfunded” credit shelter trust that triggers Illinois estate tax at the death of the first spouse. For many families, the combination of the increased exemption and the availability of federal portability may render formula division no longer necessary. This does not mean that a trust(s) is no longer necessary(!), but it does mean that formulas should be reviewed, and in some cases, revised.

3. Consider (or Reconsider) Lifetime Gifting

The new $11.2 exemption applies not only to estates, but also to lifetime gifts. Individuals who previously used all or most of their lifetime exemption now have another $5.71 million to “play” with in 2018. This also applies to longer term generation-skipping transfers (think ‘dynasty trusts’). Gifting can also be quite effective at minimizing Illinois estate tax. But don’t forget the capital gains tax implications when gifting. Your lifetime donee (I like “giftee”) takes your capital gain tax basis. But your estate beneficiary will generally get to adjust basis upward to date of death value. So lifetime gifting of highly appreciated assets poses some downside. Consider instead gifting cash or depreciated assets and retaining appreciated investments. For a tax-geek type of assessment as to whether a “clawback” estate tax could be assessed to gifts made under a larger exemption that reverts to a smaller exemption upon death, read here. Conclusion: it’s highly unlikely.

4. Don’t Forget to Elect (Portability and QTIP)

Post-death estate tax elections at the death of the first spouse to die may now be even more critical. For a discussion of spousal portability of unused exemption, read here. With a doubled exemption, that election can potentially be twice as valuable. In addition, certain marital trusts are subject to an optional QTIP (‘qualified terminable interest property’) election. Both of these elections must be made on a timely-filed Form 706 estate tax return following the death of the first spouse.

5. Stay Tuned!

A number of rumored changes were not included in the final bill, but could be subject to change in the future. For example, there was discussion of forcing non-spouse IRA beneficiaries to take taxable withdrawals over 5 years rather than over the beneficiary’s life expectancy. There will undoubtedly be future changes in the coming years, perhaps some that cannot be anticipated, so it is always wise stay tuned in and ready to adjust plans as needed.

In my next blog entry, I will address some under-the-radar changes that effect education, disability, retirement and charitable gifting.