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Estate Planning & The New Federal Tax Law

Dear Friends:
On January 1, 2018 significant changes were made to the federal estate, gift, generation-skipping transfer (“GST”), and income tax systems.  Unfortunately, the “Tax Cuts and Jobs Act” provides neither certainty nor simplicity.
Note this article is neither covering planning for non-citizens nor for non-citizen spouses.
Some of the biggest changes that will impact estate plans include:  
Federal Transfer Tax Exemption Amounts double from $5 million to $10 million per person for all transfers (estate, gift, and GST) January 1, 2018 through December 31, 2025. Sunset 1/01/2026!

The transfer tax exemption amounts will be inflation adjusted but the calculation for inflation adjustments has changed from the Consumer Price Index (“CPI”) to the new Chained CPI (“C-CPI”).
Unlike the CPI, which examines a fixed basket of goods and services, the C-CPI is calculated assuming that consumers make substitutions as the cost of goods rise. For example, as the price of beef increases, consumers may purchase chicken. Accounting for this substitution means that inflation is seen to grow more slowly, on average about 0.25% slower under the C-CPI calculation versus the CPI calculation.
Because C-CPI provides for substitution of goods and services, it is also subject to frequent revision. Final revised data for the 2018 C-CPI calculation initially published in August 2017 may not be available until the end of 2018, so only then will we have the final inflation adjustment for 2018 increases, Yes, you correctly read this! Under the new Chained CPI, the 2018 exemption amount is anticipated to be $11.18 million per person.
Planning for higher basis and income tax planning is an important part of estate planning.
The old maxim “when in doubt, gift it out” has changed since many people are less concerned about estate tax planning and they are more concerned about basis and income tax planning for themselves and their loved ones.
Clients who are less concerned about estate taxes may need to look at income tax planning in new ways even if they or their beneficiaries are not “high” income taxpayers. The sale of even one asset may bring a normally lower income tax bracket taxpayer into a higher income tax bracket, create the loss of deductions for the normally lower bracket taxpayer, and bring on the 3.8% Medicare Surtax AKA Net Income Investment Tax which continues under the new federal tax law. This would not be a nice surprise for anyone!
Note 2018 Trust and Estate Federal Income Tax Rates:  Irrevocable trusts and estates with income over $12,500 pay $3,011.50 plus 37% on the excess over $12,500.
Also note Medicare Surtax Lives: The Medicare Surtax of 3.8% on all net investment income applies to Trusts and Estates with Modified Adjusted Gross Income (“MAGI”) over $12,500.
Married Clients Have Potential Planning Issues & A Planning Advantage:  Portability
If an election is properly and timely made after the death of the first spouse to die, the deceased spouse’s unused exclusion (“DSUE”) is available for the surviving spouse. This means a married couple’s “combined amount” in 2018, based on the new C-CPI, is expected to be $22.36 million.
Portability allows us to hedge our bets that Congress might reduce the transfer tax exemption amount prior to the surviving spouse’s death. 
Many married couples whose estate plans include “family” trust planning solely for estate tax planning purposes and whose combined net worth is unlikely to exceed $11 million may now prefer less complicated estate plans and they may want to look at portability planning.

Family Trusts have been long utilized to shelter the estate tax exemption of the first spouse to die from estate taxes at the deaths of both spouses. Furthermore, the value of the Family Trust, including the appreciated value at the second death, will pass free of federal and state estate tax at the death of the second spouse to die. However, there will not be a second basis step up for income tax purposes at the death of the surviving spouse.  
In the past estate tax exemptions were lower, estate tax rates higher and income tax rates lower. Today the estate tax exemptions are higher, the estate tax rates are lower, income tax rates are higher, and the income tax rates for trusts are high and compressed. This means trusts pay higher income taxes on much lower levels of income. Having a Family Trust does not make sense in cases where the trust is solely used for estate tax planning that is no longer, or soon to be no longer, necessary.  
Family Trusts are used for more than estate tax planning purposes. Therefore, even if a Family Trust is not needed for estate tax planning purposes, it may make sense to have one to address other planning purposes that may exist at the death of the first spouse to die.
If a Family Trust is not needed at that time, then it would not make sense to have it to save administrative and other potential costs.  
Family Trust creation, or not, is an example of where flexibility in estate plan documents can be very important.
It is also important to note Maryland clients may have trusts and wills containing tax formula clauses which create two Marital Trusts, in addition to a Family Trust, at the death of the first spouse to die. These formula clauses were designed to fully utilize the federal estate tax exemption of the first spouse to die without triggering Maryland estate tax at that time. Given changes in estate tax and income tax, all of these wills and trusts should be reviewed.  Even if a single Marital Trust is appropriate, we may want to consider a change from a “Traditional” Marital Trust to a “Total Return” Marital Trust.
“Total Return” Marital Trusts are designed to enable reductions in, and shifts of, income tax liability. This is very important given the compressed income tax rates for trusts, A “Total Return” Marital Trust will likely be larger than Marital Trusts under prior law, and we now have to deal with the Maryland Trust Act. Total Return Marital Trusts can also provide disability planning for the surviving spouse, some asset protection for the surviving spouse, ensure probate avoidance for the assets held in the trust at the death of the surviving spouse, and ensure trust assets go to specified beneficiaries of the decedent spouse after the death of the surviving spouse.

We must continue to plan for State Estate Tax in cases where change of domicile is not an option.
Importantly Maryland, other states, and the District of Columbia are considering legislation to reduce and/or otherwise change their estate tax exemptions in light of the new federal tax law.
Maryland was in the process of recoupling with the federal system. Maryland now has a $4 million per person estate tax exemption. On January 1, 2019, Maryland will decouple from the federal law with a $5 million exclusion amount plus any Maryland deceased spouses unused exclusion amount (“DSUEA”).
Given District of Columbia legislation enacted in 2015 and modified in 2017, the Tax Cuts and Jobs Act caused the District of Columbia estate tax exemption to jump from $2 million in 2017 to an anticipated $11.18 million on January 1st.
On December 19, 2017, DC Councilmember Mary Cheh introduced the District Tax Independence Act of 2017 (Act), which would require the Chief Financial Officer (CFO) to submit a report outlining the steps and amendments necessary to decouple the District’s tax deduction laws from federal law. As introduced, the Act would require this report by no later than April 30, 2018. The legislation was co-sponsored by Councilmembers Allen, Evans, McDuffie, Bonds, Gray, Nadeau, R. White, Grosso, Silverman, T. White, and Chairman Mendelson. Notably, all members of the Committee on Finance and Revenue—including Chairman Evans—are co-sponsors.
Note we continue to have activity in the District of Columbia regarding its estate tax which recoupled with the federal law this year. Stay tuned.
What Happens If Sunset Actually Happens January 1, 2026?
If sunset actually occurs and we return to $5 million per person, it has been estimated that the 2026 transfer tax exemption amount will be approximately $6,750,000 with annual C-CPI increases.
Can we preserve the current exemption increase before it vanishes before our eyes? It depends.
For most, clients, unless they use it or die before January 1, 2026, the increased exemption amount vanishes!
The “easiest” strategy is to have a large estate and die before Sunset (12/31/2025) with enough assets to use the exemption or with a surviving spouse electing Portability.
Selected Variables for the Future
    1. Sunset Occurs on Schedule
        Reset federal transfer exemption to $5 million plus index @ $6.75 million on 01/01/2026
    2. Congress Eliminates Sunset
        $11.8 Million plus C-CPI increases “permanent”
    3. Congress Changes the Law
        Reduces exemption amount, and/or increases tax rate, or
        Eliminates the transfer tax or reduces the tax rate
An Overarching Perspective for Estate Planning:
My Estate is well under the 2018 Federal Estate Tax Exemption, or it’s under the projected 2026 Sunset Amount ($6.75 million.).
My Estate won’t pay estate tax so….

….Let’s look at this more closely:
        For everyone, there is one day that determines whether there will be an Estate Tax:
        The day of his or her death.
        On “that day” ….
        There will be an estate tax imposed on that estate, or
        There will not.

        And the reality is…, we won’t know until we get there.

Clients Want It All:
We want high basis to minimize future gain on federal, state, and local taxes as well as possible depreciation benefits. We want no transfer tax to avoid the 40% Federal tax as well as avoid State estate tax (where applicable).
We want trust protections to protect our beneficiaries of up to 100% loss due to creditors, divorce, and other predators.
Many aspects of estate and wealth strategies planning will not change and we want these too. Wealth Creation including opportunity spotting, investment planning, and planning with life insurance. Wealth Preservation including disability planning, probate avoidance, as well as asset and predator protection. Wealth Distribution including empowering beneficiaries and empowering charitable causes. We want to transfer not only the “value” of our assets but also our “values.” 
Time for Action  
It is important for clients and their skilled collaborative planning professionals (estate attorney, C.P.A., financial consultant, insurance advisor) to design, implement and maintain estate plans with flexibility to navigate currents and to make course corrections as clients, their families, the world, and the law change.
The time to act is now.

This information was prepared by Lena Barnett & Associates, LLC and is intended only to provide general information.
It is neither offered nor intended for use as legal advice, nor is it a substitute for a consultation with an attorney.

© 2018 Lena Barnett & Associates, L.L.C. All Rights Reserved


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