The new federallaw provides a gift to wealthy individuals—a doubling of the estate and gift-tax exemption.
Even before tax reform, the odds were remote that individuals would have to pay federal estate taxes. Now, they are downright minuscule.
The Tax Cuts and Job Act of 2017, passed by Congress last December, is best known for cutting corporate and individual taxes. But for very wealthy families, the new tax law means they get to keep more of their money before the federal estate taxman comes knocking. (There are no such worries in Ohio, which has eliminated the estate tax on the state level.)
The federal law doubles the estate and gift-tax exemption to nearly $11.2 million per person or $22.4 million per couple. That's the amount a person or couple can pass along as gifts during life or assets left at death before they are subjected to federal estate tax. The federal exemption is adjusted for inflation. Amounts above those levels are taxed at a 40 percent rate.
The law is expected to reduce the number of taxable estates by about two-thirds in 2018 and save the heirs of a few thousand people almost $7 billion, according to the Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution. Only about 1,700 estates will owe federal estate tax this year, less than 0.1 percent of all estates.
The law didn't change the rules on what is called “portability” that offers a generous tax break for wealthy married couples. It allows the unused portion of one spouse who has died to transfer to the surviving spouse provided an estate tax return has been filed when the first spouse dies.
Also remaining the same is the treatment of capital gains. Assets are passed along by the estate at their value at the time of their death.
For example, shares of a stock worth $50 per share at the time of death that were purchased in a taxable account for $10 per share aren't subject to a tax on the gain. Heirs who receive the shares then have the $50 share price as the starting point for measuring a taxable gain when they sell. This is called the “step-up in basis.”
But the tax break on the value of the estates is temporary. It stands to expire in 2025, and if nothing happens to the law between now and then, the old rules go back into play. That's why it is important for taxpayers to have their estate plans reviewed by their advisers and lawyers, especially in cases where those taxpayers are likely to die before 2025. “It really is the best recommendation for anyone, regardless of the size of their anticipated estate, to meet with an estate planning attorney and advisers to take a look at what you have to make sure you have a plan in place for passing along the assets you want regardless of the amount you have,” says Kim Mayhew, regional director of personal trust for Fifth Third Bank.
One key way couples can act is to start giving away their assets while they're still alive. That reduces the value of the estate so that if Congress does nothing, then the value of the estate will be reduced so that families can avoid estate tax if the old rules come back, says Geoff Kunkler, a partner with the Carlile, Patchen & Murphy law firm and chairman of the Columbus Bar Association's estate planning and trusts committee.
The law allows any taxpayer to transfer assets of up to $15,000 per year to anyone without using of the $11.2 million gift-tax exemption. For a married couple, they could donate $30,000. The number is adjusted for inflation. No gift tax is owed until the entire exemption is used.
Giving gifts allows taxpayers to pass along some of their wealth while they're alive to children, grandchildren or other relatives and friends. Money also could be put into a trust so that the recipient doesn't have immediate access to the money.
Kunkler has a client who wants to give away a portion of the family farm to a child to be used for a house. “Grandma and grandpa can watch the kids across the street because they're building a house on the land,” he says.
Beyond estate planning, the new tax law reduces incentives to donate to charities. The law nearly doubles the standard deduction from $6,350 to $12,000 for single filers and from $12,700 to $24,000 for couples filing joint returns.
The tax plan eliminates some deductions and reduces the value of others. The deduction for state and local taxes, for example, is capped at $10,000.
The tax overhaul also eliminated the 80 percent deduction taxpayers receive for donations to universities for the right to buy seats at athletic events, a deduction that figures to hurt Ohio State University.
A married couple filing jointly will need at least $24,000 in deductions from mortgage interest, state and local taxes, donations and other write-offs to file Schedule A, the tax form used to claim these deductions for taxpayers that itemize their return.
The Tax Policy Center estimates that the number of households that will claim an itemized deduction for their charitable gifts will shrink from about 37 million to about 16 million in 2018. The law is expected to reduce the federal income-tax subsidy for charitable giving by one-third, to about $42 billion.
One solution is called “bunching” in which taxpayers donate as much as they regularly would over two or more years but do it in one year, says Miranda Morgan, a partner with the law firm Ice Miller in Columbus. That way they can still take full advantage of charitable donations in the year they donate and take off the increased standard deduction in other years.
Taxpayers who will not itemize every year can set up what are called donor-advised funds or other methods to make donations, she says. The advantage of setting up such a fund is that they generally allow an immediate tax deduction and the money can be invested for tax-free growth. Then the taxpayer can recommend grants to qualified charities. Of course, that can mean a big cash commitment that may be tough to reach.
Despite the increase in the standard deduction, plenty of families still will be able to itemize their return and take advantage of their typical charitable deductions, Morgan says. It would not be out of the ordinary for a married couple to take the maximum deduction for state and local taxes combined with mortgage interest along with donations to continue allowing families to itemize their returns, she says.
Irrespective of the new law, there may not be a substantial reduction in donations just because fewer taxpayers can claim charitable deductions on their return, she says. “That ignores that a lot of people give because it is the right thing to do, not just because of a tax deduction,” she says. “You could also argue that donations will increase because people will have more cash in their pocket [from the tax cut], encouraging people to be more charitable. That's a positive way to look at it.”
Mark Williams covers banking and insurance for the Columbus Dispatch.