Last month, I promised that I would cover the estate planning consequences of the “Tax Cuts and Jobs Act” in this month’s column. At the time that previous column was due, the final version of the bill had just passed, and I still needed time to figure out what was in it.
And there is a lot in it. Most of it doesn’t have anything in particular to do with estate planning, though. And the parts of the bill that do affect estate planning, don’t change a whole lot about what you should do.
The most notable change is to the estate tax. The unified credit amount – that’s the amount below which you don’t have to pay any estate tax – has now doubled, from roughly $5.6 million, to more than $11 million. For a married couple, this means that as long as you aren’t leaving more than $22 million behind (twice the single amount), you don’t have to worry about estate taxes.
That’s quite a change from when I was in law school in the 1980s. Back then the exemption was only $600,000. A lot more people needed to worry about it back then.
But all that means is that a relatively small group of people, who have between $11 million and $22 million in assets, no longer have to twist their finances into pretzels to avoid the estate tax. The vast majority of people didn’t need to do that anyway, because really, how many people are over $11 million in the first place? And the very rich, the people who have more than $22 million, are still going to have to go through some weird gyrations, because the rate for the estate tax is a whopping 40 percent. That’s right, everything they leave behind, above that first $22 million, is hit with a 40 percent tax. So all of these fairly bizarre and complicated estate tax strategies are still necessary for people at the upper end.
Frustratingly, though, the increased exemption expires in 2025. So who knows, maybe those mid-wealthy people (over $5.5 million but under $22 million) will have to go back to their lawyers for tax planning at that point.
Talking about the estate tax credit reminds me: there are still a lot of people who have “A/B Trusts” from years back, when that strategy was necessary. Even for the super-wealthy, nobody needs the restrictive provisions which those trusts imposed. Back before 2011, these A/B Trusts were necessary in order to double up the exemption for a married couple. If you still have one of those old trusts, and it isn’t fixed, and your spouse dies, the trust will unnecessarily restrict your access to your own assets. If you have a trust that appears to split into two different trusts after the first spouse dies, you need to see an estate planner right away. You don’t want that anymore.
But back to the Tax Cuts and Jobs Act. Most of the news coverage has been about the lowering of the income tax rates. Income tax is the one tax which affects just about everybody, just about every year. The tax cuts in the new bill are pretty substantial, but for the most part they do not affect estate planning. And the one place that they might have affected estate planning, they really don’t.
You see, income taxes don’t apply to most assets you inherit. If Mom leaves you her house, and it is worth $300,000, you don’t have $300,000 of taxable income. You just get the house, tax free. But if Mom leaves you an IRA, or any other tax-deferred account, worth $300,000, that is taxable income. How much tax you have to pay on it, depends on what you do next. If you know something about how this works, you roll that money into a beneficiary IRA, and take it out gradually over time. This keeps your tax rate down to a manageable level.
But let’s say you don’t know about these things, and you cash out that inherited IRA. The whole thing would count as ordinary income in one year, which means you just added $300,000 in taxable income to whatever you actually made. Under the old tax law (before the recent bill) you could easily have ended up in a tax bracket of almost 40 percent. That percentage goes down under the new law, but it doesn’t go down that much. Because the Congress didn’t want to be accused of passing “tax cuts for the rich”, they didn’t lower the percentages as much at the upper levels. See, if you cash out that IRA you inherited, you could still easily end up at a 37 percent tax rate. That is better than 40 percent, but not dramatically better. So it is still really critical that once someone inherits a tax-deferred account, they handle it correctly so they don’t jump into a really high tax bracket for the year.
Finally, the long term capital gains tax rates went down. The exact percentage depends on your tax bracket, but for most folks it probably means that if they sell an asset which has gone up in value, they will pay 15 percent on the profit instead of 20 percent. That probably is not enough of a difference to make major changes in how you handle your finances, but you can still eliminate the 15 percent tax without too much trouble, when the first of a married couple dies, with a community property trust.
So my take on all of this, from the limited perspective of an estate planner, is that not that much has changed. A fairly small number of wealthy people will have their estate planning simplified. It still matters tremendously what you do, when you inherit an IRA or similar account. And the capital gains tax strategies remain about the same.
The Tax Cuts and Jobs Act will have major effects on a lot of things. It will almost certainly encourage businesses to expand, and it may or may not increase the deficit. For some people, there will be huge differences in how they handle their finances. But in the realm of estate planning, the differences are fairly modest.
Kenneth Kirk is an Anchorage estate planning lawyer. Nothing in this article should be taken as legal advice for a specific situation; for specific advice you should consult a professional who can take all the facts into account. Especially on this tax stuff.
