Public Law 115-97, commonly referred to as the Tax Cuts and Jobs Act (the"Act"), was signed into law on Dec. 22, 2017.1 The Act significantly altered many provisions of the Internal Revenue Code, resulting in substantial changes to the calculation of personal and entity-level income taxes and the further reduction to the pool of individuals to whom the estate, gift and generation skipping transfer taxes will apply. Although less than .02 percent of taxpayers are affected by the federal wealth transfer tax, depending on an individual's age and life expectancy, taxpayers who would not be subject to an estate tax under the current exemption levels may still find opportunities for making lifetime gifts. 2 By incorporating flexibility in the structure and mechanics of a client's estate plan, practitioners can assure a client who is uncertain about the future "opportunity cost" of his/her gift that his/her plans can adapt with changing family and legal circumstances. Even for those individuals who are not likely to be affected by the federal estate or gift tax, several constants remain which should continue to drive estate planning, including state estate tax reduction or avoidance, asset protection or using the larger exemption to cushion smaller gifts of hard-to-value assets from the risks of an audit.
Changes to the Wealth Transfer Tax System
After several weeks of partisan negotiations, on November 2, 2017, House of Representative Republicans presented their first iteration of the proposed tax bill. Anticipating the probability of a Democratic filibuster if a permanent bill with a 60 vote-requirement by the Senate was proffered, Republicans incorporated a "sunset" provision, requiring only a simple majority but restricting the law's applicability to eight years. Although the bill presented to the House of Representatives included the repeal of the estate and generation skipping transfer (GST) taxes, the Senate's version of the bill proposed a doubling of the estate, gift and GST tax exemptions. The Conference Committee ultimately adopted the Senate's version, which became law with the passage of the Act.
The Act nearly doubled the wealth that individuals can transfer without incurring a wealth transfer tax from an already historically high $5,490,000 to $11,180,000 (technically the "Basic Exclusion Amount," but often simply referred to as the "exemption," and, as was the case under prior law, will be indexed for a cost of living inflation adjustment. The exemption levels will return to $5 million (indexed for inflation) on Jan. 1, 2026, when many provisions of the Act expire, or perhaps even sooner if a newly elected administration legislates preemptively. 3 Taxpayers were confronted with a similar scenario in 2011 and 2012, when the $5 million exemption was slated to return to $1 million at the expiration of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Public Law 111-312 ("the 2010 Tax Act") on Dec. 31, 2012. 4 Anticipating the possible 80 percent reduction in the exemption, a large number of potentially affected taxpayers were presented with the opportunity to remove wealth from their taxable estates. For example, had the exemption reverted to previous levels, many individuals owning life insurance policies would have likely had gross estates in excess of a $1 million exemption. Therefore, the onus driving individuals to make gifts during 2011 and 2012 was largely the concern that the increased gift tax exemption might lapse.
Despite the gifting opportunities of 2011 and 2012, practitioners cautiously advised clients of the possibility that large transfers could be"clawed back"and subject to estate tax if the taxpayer died in a year in which the estate tax exemption failed to exceed the gift tax exemption used for an earlier gift. The American Taxpayer Relief Act of 2012 (ATRA), passed on Jan. 1, 2013, extended the $5 million estate tax exemption amount, so this issue never surfaced. Lessons learned from the possibility of ATRA's sunset at the end of 2012 indicate that it is unlikely that the Internal Revenue Service (IRS) would apply a clawback. Section 2001(g)(2) of the Act, originally sourced from the 2010 Tax Act, authorizes the Treasury Department to issue regulations to address the potential for a clawback. The legislative history seems to indicate that the intended purpose of the request for regulations stems from the technicality of drafting regulations sufficient to prevent gifts exempt from gift tax from being clawed back. Nevertheless, until regulations are issued, practitioners should continue to advise clients of the possibility of a clawback.
1 Tax Cuts and Jobs Act, Pub. L. No. 115-97, 12/22/17.
2 With a Basic Exclusion Amount of $5,430,000, 99.8 percent of taxpayers would not be subject to the estate tax. Joint Committee on Taxation, History, Present Law, and Analysis of the Federal Wealth Transfer Tax System, March 16, 2015, JCX 52-15.
3 The Act utilizes the Chained Consumer Price Index for All Urban Consumers ("C-CPI-U") instead of the Consumer Price Index for All Urban Consumers ("CPI-U") as a measure of inflation, which will slow the typical increase in the annual inflation adjustment in future years. I.R.C. § 2010(c)(3)(C).
4 The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Public Law 111-312 ("the 2010 Tax Act") established an estate tax exemption of $5 million, effective Jan. 1, 2010 through Dec. 31, 2012. I.R.C. §§302(a), 101(a).
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