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New Tax Law Creates Opportunities-Also Problems

Mary frowned at the local newscaster on the television. “I swear I have no idea what he’s talking about with this new tax law. He keeps talking about the estate tax this and the gift tax that. I have no clue what’s up and what’s down.”

Her husband, John, replied, “Changes in the tax laws seem to affect everything. And that increase in the gift tax exemption might mean we should be giving more money to the kids now, rather than waiting until after our death. I’m not sure I understand everything about the new law, but I know the value of my business has jumped in recent years. I would hate for the kids to get penalized for that. Maybe if I start gifting shares now, I could decrease the value of the estate and still avoid estate taxes.”

John continued, “Before this new law, that didn’t seem possible without getting penalized. I say we take advantage of the new law while we can. It’s not going to last forever. Perhaps we need to set up a meeting with our estate planner.”

The Tax Cuts and Jobs Act of 2017 (TCJA), effective January 1, 2018, may reduce your income tax liability, but it could play havoc with your estate plan.

That’s because while the TCJA temporarily doubles the amount of wealth exempt from the 40 percent federal estate tax, that provision expires in the year 2026. Currently, the new law exempts assets totalling $11 million for individuals and $22 million for couples (subject to adjustments for inflation) from the tax imposed on estates, gifts, and generation-skipping transfers (GST). However, in 2026, that exemption will drop back down to pre-2018 rates—approximately $5.5 million for individuals and $11 million for married couples, again adjusted for inflation.

In addition, the new law will not impact state estate and/or inheritance taxes—unless the state level of taxation is linked to the federal rate. That means in some states, the new federal estate tax exemption could actually increase the state estate tax liability, a tax 13 states plus the District of Columbia still impose. California, along with 36 other states, has eliminated estate taxes. However, when property or heirs are located in one of the still-taxing states, there could still be a substantial financial impact.

As of early 2018, the following states still imposed estate taxes:

  • Estates valued at under $2 million are exempt from estate tax, with the tax liability topping out at 12 percent.
  • Delaware. Currently estates valued at over $5.49 million (the previous federal rate) are exempt from state taxation, a rate that cannot exceed 16 percent.
  • The state estate tax exemption is tied to the federal estate tax exemption and the top tax rate is 16 percent. In addition, Hawaii permits “portability of the estate tax exemption.” That means the first spouse to die may transfer any unused portion of his or her exemption to a spouse.
  • Estates valued at $4 million or less are exempt from taxation. Any non-exempt assets may be taxed up to 6 percent.
  • The state tax exemption is set at $1 million.
  • The exemption is tied to the federal exemption with a top tax rate of 12 percent.
  • The state’s estate tax exemption is set at $3 million, with a top tax rate of 16 percent on the overage.
  • The estate tax rate may not exceed 16 percent. The exemption applies to estates valued at over $1 million.
  • The tax exemption is scheduled to top out at $2 million in 2018. In addition, a nonresident decedent’s interest in certain corporate entities is taxed.
  • New York. The exemption was scheduled to continue to increase on an annual basis until it matched the federal estate tax exemptionin 2019, with a top tax rate of 16 percent. That may change with the increase of the federal tax exemption.
  • Rhode Island. The exemption limit is set at $1.5 million, with a top tax rate at 16 percent.
  • The exemption limit is set at $2.75 million, with a top tax rate of 16 percent.
  • The exemption is set at $2.129 million, with a top tax rate of 20 percent.
  • The District of Columbia. Washington, D.C taxes estates at a top rate of 16 percent, with the exemption set at $1 million.

It is very important that estate plans be reevaluated to assess the impact of new federal law. There are some opportunities—such as an increase in permitted lifetime gifts—that must be addressed before the law reverts back to previous rates.