In 2019, the significant increase in the federal estate tax exclusion to $11.4 million left some people thinking estate and tax planning was not so important anymore. However, the higher exclusion is slated to return to only $5 million (inflation indexed) at the end of 2025. Also, for Washington residents, the state estate tax exclusion is just $2.193 million, which is easy to reach once you take into consideration your home, and the entirety of your investment accounts, 401Ks, IRA’s and bank accounts.
It is now the time to plan defensively. The following are six important estate planning considerations to discuss with your attorney, which could save you and your heirs a considerable amount.
- Review Tax Planning Strategies in your Will. Prior to 2018, many estate plans included credit shelter trust strategies. This type of planning allows married couples to take advantage of state and federal estate tax exclusions. This trust strategy is structured such that upon the passing of the first spouse, specified assets (often a dollar value up to the federal or state estate tax exclusion) pass to the credit shelter trust. These assets then flow to the surviving spouse, but due to the nature of the trust, the surviving spouse never actually owns or takes control of the assets. Therefore, the trust assets are not included in the surviving spouse’s taxable estate.
- Stay Flexible. Many of the changes enacted by the Tax Cuts and Jobs Act of 2018, including the higher federal estate tax exclusion, are set to expire at the end of 2025. As a result, the federal estate tax exclusion amount will be reduced back to $5 million (inflation indexed) after 2025. The Washington estate tax exemption will likely increase incrementally, still leaving it lower than the federal tax exemption. Considering this, building flexibility into trust arrangements will be important, especially for estates that exceed about $2.5 million. How do you maintain flexibility?
- Allow Beneficiaries to Make Changes. The trustor might want to enable beneficiaries to change the terms of the trust to benefit other heirs or charities. For example, instead of leaving the estate in equal shares among beneficiaries.
- Allow the Grantor to Substitute Trust Assets for Tax Purposes. You can allow the grantor to pay an irrevocable trust’s taxes or substitute low-cost basis trust assets to another trust with different terms, for the benefit of one or more beneficiaries of the first trust. This can help reduce tax liability.
- Give a Trust Protector Special Modification Power. A trust protector is a separate party who is authorized to do special duties regarding a trust. These may involve directing trustees in their management of the trust. Enabling trust protectors to modify certain details of the trust lends itself to enhanced flexibility.
- Be Careful About Undoing Prior Planning. If the estate tax had been eliminated as part of the Tax Cuts and Jobs Act, as some had expected, some individuals may have considered undoing prior planning they had done to avoid estate taxes. Some individuals may still be considering it given the increase in the federal estate tax exclusion. However, the uncertainty about what will happen after 2025 suggests individuals should exercise caution when it comes to undoing any prior planning because the doubling of the federal estate tax exclusion amount is set to last only 8 years.
- Consider Upstream Gifts of Low-cost-basis Assets. Individuals whose parents do not have federal estate tax concerns (even if they live past 2025), may be able to make gifts of low-cost-basis assets to their parents, in hopes of getting a step-up in cost basis at the parents’ deaths. The assets would then be transferred to children or other beneficiaries, without built-in capital gains. (Note that steps should be taken to protect against potential negative tax consequences in case the donee should die within one year of the gift).
The topics outlined above are some considerations that new tax reforms have brought to the forefront. Generally, you should review your estate plans with your attorney and tax advisor on a regular basis to ensure that your plans still are in line with current laws, and your personal needs.