The Tax Cuts and Jobs Act (the “Act”), which was passed by the House and Senate this week, will have important implications for estate planning and for saving for a child’s education. It is therefore important to understand the provisions contained in this new law, which will take effect on January 1, 2018.
In the year 2017, the federal estate, gift, and generation-skipping transfer tax (“GST”) exemptions for U.S. citizens and resident aliens were $5,490,000. Under the Act, these exemptions are being increased to $10,000,000, which will be indexed for inflation, but with the base year of 2016 based on the “chained CPI”. This means that the calculation of CPI will take into account consumers’ preferences for cheaper substitute goods during inflation. In the year 2018, the exemptions will, therefore, be $11,200,000. If any property is transferred above the increased exemption amount, it will continue to be taxed at a rate of forty (40%) percent. Although the doubling of the estate tax exemption appears to protect large estates from the estate tax, it is important to note that the Act provides that on January 1, 2026, the exemptions will revert to $5,000,000, indexed for inflation. Therefore, in 2026, the estate, gift and GST exemptions are expected to be approximately $6,200,000. Under the Act, although the exemption amount will change, the step-up in basis for property owned at death is retained.
New York Residents
Unlike New Jersey, New York law may change as a result of the Act. Currently, if a New York resident dies on or after April 1, 2017, and on or before December 31, 2018, the New York State basic exclusion amount (“BEA”) is $5,250,000. On January 1, 2019, the New York BEA is scheduled to increase to equal the federal estate tax exemption. It is possible that in 2019, the New York estate tax exemption will be between $5,600,000 and $6,000,000. However, it is uncertain at this time exactly what the New York BEA will be in 2019, because when the New York legislature passed the law changing the amount that could be excluded from a decedent’s estate, it did not know that the federal estate tax exemption would double. In addition, estates of New York residents will continue to be taxed at a maximum rate of sixteen (16%) percent. Further, if the value of an estate of a New York resident is higher than the New York exemption amount by more than five (5%) percent, the estate tax “cliff” will continue, which means that the estate will have no New York State estate tax exemption. Therefore, New York residents with estates over $5,000,000 will still need to remain concerned about the possibility of their estate being required to pay New York State estate tax.
For New York residents who own real property, it is important to be aware that effective January 1, 2018, the Act will repeal all deductions for state and local taxes above $10,000. This means that a taxpayer will be able to deduct only up to $10,000 of state property or income taxes on their personal returns. In order to allow for deductibility of 2018 property taxes on an individual or married couple’s 2017 income tax return, Governor Andrew M. Cuomo has signed an emergency Executive Order which allows New York residents to prepay 2018’s property taxes this year before the Act takes effect. However, in order for the prepayment of 2018 property taxes to be considered timely, prepayments must be mailed and postmarked on or before December 31, 2017.
New Jersey Residents
New York and New Jersey residents should also be aware of how the Act may affect state estate taxes. It appears that New Jersey will not be affected by the Act’s change to the exemption amount, because, for New Jersey residents dying on or after January 1, 2018, there is no New Jersey estate tax. However, New Jersey residents should be aware that New Jersey still has an Inheritance Tax, which applies to the following beneficiaries: (i) brother or sister of a decedent, (ii) spouse or surviving spouse of a child of a decedent, (iii) civil union partner or surviving civil union partner of a child of the decedent, and (iv) any non-“Class A” beneficiaries.
Gift Tax Exclusion
From 2014 through 2017, the annual gift exclusion was $14,000. As a result of inflation, in 2018, the annual gift exclusion will be increased to $15,000. This means that in 2018, an individual will now be able to make tax-free gifts of up to $15,000 per year, per donee.
The Act also contains beneficial provisions for parents and other family members who want to save for their children’s educational expenses. Prior to the passing of the Act, a 529 Plan or “qualified tuition program” only allowed for tax-free distributions to be made from the 529 Plan for a child’s college expenses. The Act expands the usage of 529 Plans by allowing tax-free distributions to be made from the 529 Plan for a child’s elementary and high school expenses. The Act provides that after December 31, 2017, the term “qualified higher education expense” will include distributions from a 529 Plan which are used for tuition expenses in connection with enrollment or attendance at an elementary or secondary public, private or religious school. However, it is important to be aware that there is a $10,000 limitation per beneficiary and per taxable year on the number of cash distributions from 529 Plans for elementary or secondary school. In addition, although the House Bill at one point contained a provision allowing 529 Plans to be used for homeschool expenses, the Act excludes this provision.
Beginning on the date of enactment and until December 31, 2025, the Act also allows funds to be rolled over from a 529 Plan into an ABLE Account (a tax-advantaged account for individuals with disabilities and their families), without penalty as long as the ABLE Account was owned by the designated beneficiary of the 529 Plan or a member of the designated beneficiary’s family. The amount that could be rolled over would be up to the annual ABLE contribution limit ($14,000 for 2017, $15,000 for 2018). This change will be helpful to parents who originally opened a 529 Plan for a child who later developed a disability, as it will allow the funds to be used for “qualified disability expenses” (education, housing, transportation, employment training and support, assistive technology, personal support services, health care expenses, financial management and administrative services) rather than for “qualified higher education expenses.” Also beginning on the date of enactment and until December 31, 2025, the Act further increases the ABLE contribution limit by providing that after the ABLE contribution limit is reached, the designated beneficiary of an ABLE Account can contribute to the ABLE Account an additional amount up to the lesser of (i) the individual’s compensation for the tax year, or (ii) the federal poverty line for a one-person household as determined for the preceding calendar year.
Before the Act passed, there had been some discussion regarding the possibility of changes to the capital gains tax rates and taxation of the income interest. However, the final version of the Act left these items unaffected. Still, it is important to note that since individual tax brackets have changed, it is possible that an individual’s short-term capital gains tax could be affected.
Grantor Retained Annuity Trusts
In order to take advantage of the higher exemption amount in 2018, it is recommended that individuals with estate tax planning issues set up trusts and make gifts into trusts for the benefit of children and grandchildren. For those who own appreciating assets, it is recommended that they set up four (4) to eight (8) year grantor retained annuity trusts (“GRAT”). Such trusts would be beneficial regardless of whether the Grantor survives the term of the GRAT because (i) if the Grantor were to die during the term of the trust, the trust assets would still receive a step-up in basis, or (ii) if the Grantor were to survive the term of the trust, the value of the appreciation of the trust assets could be passed on to beneficiaries. In addition, with the higher exemption amount, decanting is recommended because it allows the property to be moved to a new trust, which can grant to a beneficiary a contingent general power of appointment. Having a general power of appointment over trust assets would result in the assets being includible in the beneficiary’s estate, and such assets would receive a step-up in basis at the time of the beneficiary’s death.
Non-Resident Aliens Planning Considerations
Although the Act does not change the exemptions for non-resident aliens, it is important to be aware of the exemption amounts applicable to non-resident aliens, as they are very different than those for U.S. citizens. The estate tax exemption amount for a non-resident alien is only $60,000. This means that a non-resident alien decedent who owns assets in the U.S. can only transfer $60,000 of such assets free of U.S. estate tax to beneficiaries. Unlike U.S. citizens and resident aliens, non-resident aliens do not have an exemption amount available for lifetime transfers. However, there are two (2) exceptions to these rules: (i) a non-resident alien can transfer an unlimited amount of assets free of estate or gift tax to a U.S. citizen spouse; and (ii) for gifts made in 2018, a nonresident alien will be permitted to transfer $152,000 (up from $149,000 in 2017) free of gift tax to a non-citizen spouse.
In conclusion, the Act will have significant effects on estate planning and planning for a child’s education. Please feel free to contact us with any questions about how the Act will apply to your particular circumstances.