Fong Law Group

No Clawback—Good News from the IRS

“The Trump tax cuts bestowed a huge gift on the rich—a doubled estate and gift tax exemption. However, it’s temporary, and there was unease as to whether gifts would be taxed later, when the exemption fell.”

The IRS handed the wealthy a holiday gift just in time. It has come out with proposed rules saying there is no clawback on these lifetime gifts. The wealthy are able to pass on tens of millions of dollars that will be estate, gift and GTS-tax free, with no fear of being taxed retroactively. This good news comes from the Forbes’ article “IRS Hands The Rich Certainty On Trump Estate Tax Sweetener: No Clawback On Huge Gifts.”

The Treasury has confirmed that this is a “use it or lose it” situation. This is important not only to avoid the 40% gift and estate tax, but also the 40% generation skipping transfer tax exception. It preserves the $11 million-plus exemption, not only for children but also for grandchildren and several generations to come.

Before the new tax laws—in 2017—the estate and gift tax exemption was a mere $5.49 million. It’s taken a giant leap: $11.4 million per individual and a whopping $22.8 million for married couples for 2019.

The Tax Cuts and Jobs Act (TCJA) doubled the $5 million base to $10 million through the end of 2025. Estate planning attorneys have encouraged clients to make huge lifetime gifts, by using that extra $5 million exemption.

The concern was that if you read the entire law, word-for-word, based on the tax computations, you’d get a nasty surprise. Legally, the question was whether the increased exemption was a “loan” to the taxpayer until 2025, when exemptions return to prior levels, or if it was permanently gifted.

Let’s say you made a $9 million gift in 2018, but you died in 2026 after the exemption levels reverted to $5 million. Your heirs would be in for an unpleasant tax surprise, owing taxes on that extra $4 million gift.

But the new rules from the IRS now say that the full $9 million is tax exempt—forever.

Congress spotted the problem and gave the IRS authority in the TCJA to solve the problem administratively, which is exactly what the IRS has done. Estate planning attorneys can now let their clients know that their gifting strategies can be worry free.

A hearing to review the proposed rule will take place in March 2019.

Reference: Forbes (Nov. 21, 2018) “IRS Hands The Rich Certainty On Trump Estate Tax Sweetener: No Clawback On Huge Gifts”

Mind the Gap: Estate Tax Cliff

“When the Tax Cuts and Jobs Act went into effect, many clients and advisors assumed that their days of worrying about the estate tax were largely over. Not so fast.”

The big news was that the Tax Cuts and Jobs Act doubled the federal estate tax exemption to $11.18 million per person (and $22.36 million per couple, with portability). This enormous exemption increase gave many Americans who are in the highest of all tax brackets a reason to cheer. However, in reality, few wealthy Americans ever pay the tax. However, according to “Beware the Estate Tax Cliff,” an article appearing in Wealth Management, it’s not all good news.

For one thing, such a huge increase means that many estate plans that factor in the old exemption in complex ways, have been thrown out of whack. Many wills were created before the exemption increase and some provide directions that no longer work. If the will says, “send to my credit shelter trust an amount equal to the federal exemption,” that means $11.18 million is now headed to a credit shelter trust. That might not be what the clients were expecting to happen.

It’s not hard to understand. Plans that were perfectly balanced with a $5.4 million exemption are now being upended by doubling that amount.

Let’s also not forget about state estate taxes, which is what most people do pay.

The Act has no bearing on state estate taxes. In the past few years, many states have passed laws to ensure that the state estate tax exemption matched the federal one—before it was doubled. As a result, there is now a $5 million gap between federal and state estate tax exemptions. A plan that centers totally on leveraging the new larger federal exemption, could end up exceeding that state exemption amount.

Only about 14 states implement estate taxes for deaths after Jan. 1, 2018, and the state estate tax rates are usually much lower than the 40% federal rate. However, you still need to be aware of the specific rules and exemptions that apply in your state. You don’t want your heirs to get hit with an unexpected tax bill.

If you live in New York, a word to the wise: New York is the largest state that still levys a state estate tax. Not only is there still a large gap between the New York State estate tax exemption and the federal one, but New York has an added wrinkle of applying the exemption differently.

An estate is normally taxed based on a percentage of the amount by which it exceeds the exemption. That initial exemption is almost always tax free. However, New York implements a “cliff rule,” where if an estate exceeds the exemption by more than 5%, the exemption is effectively ignored, and the entire estate gets taxed. If you’re even 5% over, you’re in for it. New York also doesn’t have portability. With a top rate of 16 percent, that’s a nasty tax surprise.

Whether you live in New York or Kansas, talk with your estate planning attorney about how the new federal exemption impacts your estate plan and whether any changes need to be made before the end of the year.

Reference: Wealth Management (Sep. 17, 2018) “Beware the Estate Tax Cliff”