By Carol A. Magyar, CPA, MST
Tax Director

When the Tax Cuts and Jobs Act of 2017 more than doubled the federal estate tax exemption, estate planning strategies changed for many taxpayers. No longer subject to federal estate taxes because their estates fell below the exemption level, their focus turned to minimizing other taxes that could impact their heirs, such as capital gains taxes.

What became clear was that certain estate planning strategies designed for previous tax law didn’t work well under current law. Some taxpayers are still catching up with this fact. If you have not revisited your estate plan within the past three years, now would be a good time to do so.

The 2020 federal estate tax exemption is $11.58 million for individual taxpayers and $23.16 million for married couples. These exemptions are indexed for inflation, so they change slightly every year.

While saving both estate taxes and income taxes has always been a goal of estate planning, it was more difficult to succeed at both when the estate and gift tax exemption level was much lower. Here are some strategies to consider that align with current law.

Plan gifts that use the annual gift tax exclusion. One of the benefits of using the gift tax annual exclusion to make transfers during life is to save estate tax. This is because both the transferred assets and any post-transfer appreciation generated by those assets are removed from the donor’s estate.

However, if estate tax savings are no longer a goal because of the large estate exemption amount, making an annual exclusion transfer of appreciated property carries a potential income tax cost because the recipient receives the donor’s basis upon transfer. Thus, the recipient could face capital gains tax on the sale of the gifted property in the future. If there’s no concern that an estate will be subject to estate tax, even if the gifted property grows in value, then the decision to make a gift should be based on other factors.

For example, gifts may be made to help a relative buy a home or start a business. But a donor shouldn’t gift appreciated property because of the capital gain that could be realized on a future sale by the recipient. If the appreciated property is held until the donor’s death, under current law, the heir will get a step-up in basis that will wipe out the capital gain tax on any pre-death appreciation in the property’s value.

Take spouses’ estates into account. In the past, spouses often undertook complicated strategies to equalize their estates so that each could take advantage of the estate tax exemption amount. Generally, a two-trust plan was established to minimize estate tax. “Portability,” or the ability to apply the decedent’s unused exclusion amount to the surviving spouse’s transfers during life and at death, became effective for estates of decedents dying after 2010. As long as the election is made, portability allows the surviving spouse to apply the unused portion of a decedent’s applicable exclusion amount (the deceased spousal unused exclusion amount) as calculated in the year of the decedent’s death. The portability election gives married couples more flexibility in deciding how to use their exemption amounts.

Be aware that some estate exemption or valuation discount strategies to avoid inclusion of property in an estate may no longer be worth pursuing. It may be better to have the property included in the estate or not qualify for valuation discounts so that the property receives a step-up in basis. For example, the special use valuation — the valuation of qualified real property used for farming or in a business on the basis of the property’s actual use, rather than on its highest and best use — may not save enough estate tax to justify giving up the step-up in basis that would otherwise occur for the property.

A caveat: Future changes in tax law can affect estate planning. If you are considering changes to your estate plan based on the expectation of a step-up in basis, be aware that Vice President Biden’s tax proposal includes ending the step-up. If the step-up in basis is ended, any estate planning strategies based on the expectation of having it in place would have to be re-evaluated.

Contact us if you want to discuss these strategies and how they relate to your estate plan.