For many, the start of a new year means dusting off those running shoes or beginning a new diet. It can also be an ideal time to review your estate plan with a trusted advisor and consider whether any updates are needed. Federal and state tax laws change constantly, as do many families, their assets and their planning objectives, and a periodic review of your estate plan ensures that your plan achieves your current personal goals with the lowest possible tax burden. This advisory reviews the federal and state tax law landscape in 2019 and provides planning tips to get your new year started off on the right foot.
Federal Tax Laws
The Tax Cuts and Jobs Act (Tax Act) significantly changed many federal tax laws in 2018. This year, several aspects of the law have been adjusted and updated.
The federal estate and gift tax exemption, the amount you can give away without incurring tax, is $11.4 million (less prior taxable gifts) in 2019. This means that married couples can give away up to $22.8 million in assets before the federal estate or gift tax applies. For amounts over the exemption amount, the estate and gift tax kick in at the maximum rate of 40 percent (which was not changed by the Tax Act). The estate and gift tax exemption amount is adjusted for inflation annually.
The generation-skipping transfer tax exemption, the amount you can give to grandchildren or more remote generations without incurring tax, has also increased to $11.4 million per person, or $22.8 million per married couple (again, with a maximum rate of 40 percent applying above the exemption amount). The generation-skipping transfer tax exemption amount is also adjusted for inflation annually.
The exemptions from federal transfer taxes are at historical highs as a result of the Tax Act. However, the increase in the estate, gift and generation-skipping transfer tax exemptions is scheduled to “sunset” back to pre-Tax Act figures ($5 million indexed for inflation) on January 1, 2026. Although some advisors were concerned that making gifts under the current regime could result in a tax penalty after 2025, the IRS recently proposed rules that would clarify that gifts made using the higher exemption amounts would not be subject to estate or gift tax after the “sunset.” Thus, we find ourselves in a unique, and perhaps temporary, period where one can transfer a significant amount of wealth without incurring transfer taxes.
Selected State Transfer Tax Laws
Many state-level estate, gift and inheritance tax laws have also changed in the recent past.
The District of Columbia imposes an estate tax with a 16 percent top rate. On September 5, 2018, the district City Council set the estate tax exemption amount at $5.6 million, starting in 2019. The district’s exemption amount is adjusted annually for inflation. There is no gift tax or inheritance tax in the district.
The State of Florida does not impose an estate tax, gift tax or inheritance tax.
The State of Maryland imposes an estate tax with a 16 percent top rate. Maryland had set its estate tax exemption amount to equal the federal exemption level. However, following the doubling of the federal exemption amount by the Tax Cut, the Maryland legislature, on April 5, 2018, froze its exemption at $5 million beginning in 2019. Maryland’s estate tax exemption is not adjusted for inflation, so it will remain at $5 million each year. Maryland now also allows a surviving spouse to elect to use a predeceased spouse’s unused Maryland exemption to reduce their own Maryland estate tax if certain criteria are met, known as “portability” of the exemption. Maryland’s inheritance tax, which imposes an additional transfer tax on certain persons receiving property depending on their relationship to the decedent, remains unchanged. For example, no inheritance tax is imposed on the inheritance of a spouse or child, but a 10 percent tax is imposed on the inheritance of a niece or nephew. Maryland does not have a gift tax.
The State of New Jersey currently does not impose an estate tax, having repealed its estate tax in 2018. New Jersey does impose an inheritance tax, which has remained unchanged in recent years and imposes an additional transfer tax on certain persons receiving property depending on their relationship to the decedent. For example, no inheritance tax is imposed on the inheritance of a spouse or child, but a graduated tax is imposed on the inheritance of nieces and nephews. New Jersey also does not have a gift tax.
The State of New York imposes an estate tax with a 16 percent maximum rate. The New York exemption is $5 million adjusted for inflation (from 2014). Accordingly, for 2019, the New York estate tax exemption amount is $5.74 million. Notably, New York’s estate tax is a “cliff tax” in that if an estate exceeds the exemption amount by more than 5 percent, the entire estate is subject to estate tax without any exemption.
The Commonwealth of Pennsylvania currently does not impose an estate tax or a gift tax, but does impose an inheritance tax depending on the relationship between a person receiving property and the decedent. For example, no inheritance tax is imposed on the inheritance of a spouse, but a 4.5 percent tax is imposed on the inheritance of a child or other descendant.
The Commonwealth of Virginia does not impose an estate tax, gift tax or inheritance tax.
2019 Transfer Tax Planning Tips
The most obvious estate planning strategy in light of the recent federal tax law changes is to utilize the increased federal exemption amounts. Families with significant assets have the temporary opportunity to transfer a meaningful amount of wealth to their descendants free of federal (and possibly state) transfer taxes. Such gifts can be made in a number of ways, including (i) direct gifts, (ii) forgiving loans and (iii) funding trusts, including “dynasty trusts” that will create a legacy lasting for generations, just to name a few.
However, the income tax consequences of giving away assets must also be considered. Assets in a decedent’s estate receive a basis “step up” to date of death value, while assets gifted during lifetime have a “carryover basis” equal to the transferor’s basis at the time of the gift. Accordingly, it is often advisable to retain certain low-basis assets until death as the combined federal and state income taxes on the sale of these assets by a donee could be greater than the federal and state (if applicable) estate tax on the same assets if held until death. Likewise, it may be possible and advantageous, for an individual to repossess low-basis assets previously given to a trust prior to death by exercising a “power of substitution,” if available under the trust terms. Your estate planning attorney can advise you on the availability and advisability of these opportunities.
While the increased federal exemptions are universally viewed as a positive development, one should consider the impact of the increased exemptions on his or her estate plan. The larger exemption amount could, under certain circumstances, disrupt the flow of assets in an estate in an unintended manner. For example, a common estate planning technique is for property equal to the federal estate tax exemption to fund a trust (the “credit shelter trust”) that can benefit any individuals (e.g., a spouse, spouse and children, children only) and the remaining property to fund a second trust for the benefit of only a spouse (a “marital trust”). With the substantial increase of the exemption amount, it is possible that all assets in an estate will fund the credit shelter trust and the marital trust will never be funded. It is important to review your estate planning documents carefully and consider if any unintended disruption could occur as currently drafted, and if so, whether you are fine with your property being divided in this manner.
Another planning item to consider each year is most tax efficient way to utilize the annual exclusion from gift tax. The annual exclusion from gift tax, the amount you can give to an individual each year without using your gift tax exemption, is $15,000 in 2019. This exclusion amount is adjusted for inflation to the nearest $1,000. We advise individuals to determine the best use of annual exclusions gifts as early as possible each year. The sooner you determine the gifts that you would like to make in 2019, the more likely you will be able to complete the gifts and avoid a year end rush or, even worse, a missed opportunity to avoid transfer taxes. If you do not want to make gifts outright to minor children or grandchildren, gifts can be made to trusts, to custodial accounts or even to tax-advantaged education accounts.
Importantly, the direct payment of certain tuition and medical expenses for an individual is fully-excluded from gift tax. Consequently, an unlimited amount may be spent on such expenses without using gift tax exemption, provided such amounts are paid directly to the provider of these services. This is an excellent way to make transfers that benefit your children, grandchildren and even great-grandchildren without incurring transfer taxes.
2019 Income Tax Planning Tips
Finally, as most are aware, the Tax Act limited the deduction for state and local income taxes to $10,000 and also increased the standard deduction for income taxes to $24,000 for a married couple, $18,000 for a head of household and $12,000 for a single individual. These two changes mean that fewer taxpayers will be itemizing deductions on their income tax return. Taxpayers that do not itemize deductions do not get a tax benefit from their charitable contributions. However, taxpayers that take the standard deduction and are over 70½ years old may still get a tax benefit from charitable contributions if made from the taxpayer’s IRA. An eligible taxpayer can make up to $100,000 of charitable contributions per year from his or her IRA directly to charity and can exclude these distributions from his or her taxable income. Your estate planning attorney or tax advisor can determine if you are eligible for this tax benefit.
The above is just a brief summary of federal and state transfer tax laws, focusing on the current status of each and highlighting recent changes and providing some quick tips that you can implement now. We recommend that you confer with your estate planning attorney and other trusted advisors to determine what, if any, steps may be advisable considering the tax landscape we have today.