Author: Greg Lonczak, CFP® Director, Private Client Group

With the new year well upon us, you may be working with your financial planning consultant now as your year-end balance sheets are being prepared.  At Clearstead, we’re unique because we consider tax to be an integral part of wealth management planning and we have a seasoned team of tax experts that are staying on top of all available write-offs and exemptions.  

Right now, we’re encouraging our clients to take advantage of a historic tax opportunity that incentivizes them to preserve wealth for future generations: President Trump’s Tax Cuts and Jobs Act (“The Act”). Recently the IRS released proposed regulations that clarified concerns related to The Act and potential “clawback” penalties that could impact estate taxes after the law’s 2025 sunset.  We’re here to unravel the language behind these regulations and explain how you and your family can benefit now.

How does The Act benefit wealthy individuals and families?

In effect for about one year, The Act roughly doubled the estate, gift, and generation-skipping transfer tax exemption amounts from $5.49 million per person in 2017 (or $10.98 million per married couple) to $11.18 million per person (or $22.36 million per married couple) in 2018.  In 2019, these exemption amounts have adjusted for inflation to $11.4 million per person (or $22.8 million per married couple). This higher exemption is set to sunset at the end of 2025, falling back to about $5 million.

What were the planning concerns related to The Act?

After the tax overhaul became official, some fiduciary advisors were worried that if a donor were to die after 2025, any gifts made during the eight-year window of opportunity would be clawed back into the donor’s estate and then hit with the 40 percent tax.  For example, if an unmarried taxpayer made an $11 million gift in 2019, fully sheltered by the taxpayer’s gift tax exemption, but died after 2025 when the estate tax exemption amount was only $5 million, would the excess $6 million be subject to estate tax at the taxpayer’s death?

How does the proposed regulation provide clarity?

The proposed regulations have effectively made the increased exemption amounts a “use it or lose it” planning opportunity. The proposed regulation protects taxpayers who plan to make large gifts between 2018 and 2025 and then may pass away after 2025. It calls for the minimum amount of exemption to be the exemption amount in place at the time the gifts were made and not in the year of death. If the actual exemption after 2025 exceeds the previous amount of exemption used, the actual exemption amount would be applicable.

Consider, for example, an unmarried taxpayer who makes taxable gifts of $5 million in 2019 and does not make any additional taxable gifts until 2026.  If the exemption amounts decrease to $5 million in 2026, the taxpayer will have $0 remaining exemption to use after 2025. By contrast, if the same taxpayer makes an $11 million gift in 2019, the $6 million in excess of the $5 million exemption amount will not be clawed back in 2026.

When will the proposed regulation become law?

The proposed regulations will be effective once they are final. The IRS will receive comments from the public by Feb. 21, 2019 and, if comments are received, will hold a public hearing on March 13, 2019.

What planning strategies should we consider now?

There is definitely uncertainty in today’s political environment, but one thing is certain, without any laws passed to extend the current estate tax laws past December 31, 2025, today’s favorable exemption amounts will disappear on January 1, 2026.  And given the current political climate, which may result in a near change of presidency, we would highly encourage individuals with significant means to, at a very minimum, start discussions with their planners about the options available and what each option means in terms of their cash-flow, creditor protection, income taxes, and investment strategies.   While a “wait-and-see” approach may make sense for your situation, we would strongly advocate against failing to prepare.

Traditional wealth-shifting strategies, such as the use of Spousal Lifetime Access Trusts, grantor retained annuity trusts (GRATs), and leveraging exemptions through the use of valuation discounts, should continue to be attractive estate planning strategies.

As an independent investment advisor, our team of tax, investment, and research experts can help you to craft a plan that leverages all opportunities and preserves wealth for future generations. Wondering what other tax opportunities you’re missing out on? Request an invite for a no-fee ClearSight financial overview today.

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