With the New Year comes new resolutions, new perspectives, and of particular importance for the field of estate planning, a new tax law. The Tax Jobs and Cuts Act of 2017 (the “TJCA”) was signed into law on December 22, 2017. The TJCA has some significant changes in store for the 2018 tax year that may affect estate planning for many individuals.
Gift and Estate Tax.
Under the tax laws that were in effect before the TJCA, the threshold for paying federal tax on estates was $5,490,000 per individual in 2017 with the amount indexed for each year thereafter. This exemption was based upon a $5,00,000 exemption that was indexed each year after 2010. Estates that do not meet this threshold value were not required to pay federal estate taxes. The TJCA has nearly doubled this threshold lifetime exemption amount to $11,200,000 per individual Thus, a married couple under the TJCA can transfer approximately $22.4 mil. in assets through the combined exemptions. The new threshold for federal estate tax will apply to the estates of decedents who died after December 31, 2017, but before January 1, 2025. This is due to the fact that this provision is set to automatically expire on January 1, 2025, if congress does not pass legislation to continue the new threshold amount. If congress does not renew the new threshold amount by January 1, 2025, the prior threshold amount of $5,000,000 indexed for years after 2010 will once again apply. Two key provisions of the estate tax laws remain unchanged by TJCA which are the portability election for the unused estate tax exemption and the basis step-up at death to fair market value for capital assets.
Individuals with estates that are over the previous exemption amount will want to review their estate plan in light of the increased exemption amount because estate plans to avoid the federal estate tax based on the previous lower amount may no longer be necessary or may need to be restructured.
Generation Skipping Transfers.
The TCJA does not expressly mention generation-skipping transfers. However, the exemption amount for generation-skipping transfers is based upon the estate tax threshold. Therefore, it is anticipated that generation-skipping transfers will also receive the same increase in the exemption amount as the estate tax.
Recharacterization of IRA Contributions.
Under the preexisting tax laws, an individual who contributed to an Individual Retirement Account (“IRA”) could recharacterize the contribution as a contribution to another type of IRA if certain conditions were met. For example, an individual could contribute to a traditional IRA and recharacterize it as a contribution to a Roth IRA, and vice versa. This included regular contributions and conversion contributions. Under the TJCA, a conversion contribution to a Roth IRA no longer falls under the recharacterization rule. Thus, recharacterization can no longer be used to undo a Roth conversion. Normal IRA contributions may still be recharacterized.
The benefit of the old rule was to permit an individual to avoid the higher Roth IRA tax burden if money in the IRA had decreased in value after the conversion to a Roth IRA. Individuals who are considering a conversion to a Roth IRA will want to keep this change in mind.
529 Plans.
Legally known as a “qualified tuition plan,” a 529 plan derives its name from Section 529 of the Internal Revenue Code. A 529 plan is a tax advantaged savings plan for future college or education costs. Under the preexisting tax laws, amounts contributed to a 529 plan were still taxed for federal income tax purposes, but the gains when the funds are withdrawn are not subject to income tax. Although the contributions to a 529 plan are not exempt from federal income taxation, sums contributed to an Idaho 529 are deductible on Idaho state taxes up to $12,000 if married and filing a joint tax return. Under prior law, the funds distributed from a 529 plan were also limited to being used for qualifying college education expenses. Under the TCJA, funds from a 529 account can now be used for qualifying education expenses beginning with kindergarten. Withdrawals from a 529 account for qualifying education expenses are capped at $10,000 each year, per child. Account owners can also roll over 529 plans to ABLE plans, up the ABLE contribution annual limit.
In terms of preparing to meet rising tuition costs, a 529 plan can be an effective tool and may permit the owner of a 529 plan to finance private school and/or college with tax advantaged money.
Charitable Deductions.
The limit on federal tax deductions for cash gifts to public charities has increased from 50% of the taxpayers’ Adjusted Gross Income (“AGI”) under the preexisting tax laws, to 60% of the AGI under the TCJA.
Pass-Through Deduction.
Under the pre-existing tax laws, income received from partnerships, S corporations, or sole proprietorships is “passed-through” to the owner’s individual tax return, where it was taxed as ordinary income. Under the TCJA, there is a new 20% deduction for this “pass-through” income. Owners of businesses or rental properties may wish to consult with a licensed tax professional to determine whether the new 20% deduction on “pass-through” income would lower their tax burden if their business were to be restructured as a partnership, S corporation, or sole proprietorship.