Heirs inherit uncertainty with new estate tax

The tax law passed by Congress in December certainly keeps it alive — on more generous terms. Instead of taxing any amount above $5.49 million per person at a rate of 40 percent, the new law raises that exemption to $10 million, which, when indexed for inflation, allows individuals to pass on $11.2 million and couples to transfer twice that amount without paying a penny of tax.

But leaving the estate tax in place means America’s richest families now face the prospect of scurrying to tax lawyers to revise older estate plans, and may need to do so again before the end of 2025. The new exemption is on the books for only eight years, and if Congress doesn’t change the law again, estates could face tax bills after 2026 for moves made under the new, temporary limits.

“Some of the wealthier clients are happy” with the changes, said Brian Jenney, a partner with Kemp Klein in Troy, Michigan. “But when you tell them it ends in 2025, they’re frustrated because they’re still going to be alive.”

Despite these complications, what’s clear is that even though Congress didn’t kill the estate tax, the new limits come close.

“The estate tax used to cover a lot more people even in recent decades, up to 2 percent of all estates. Now we’re down to less than one-tenth of 1 percent,” said Chuck Marr, director of federal tax policy for the Center on Budget and Policy Priorities in Washington. “The estate tax is hanging on by a thread.”

According to IRS figures, 12,411 estates filed Form 706, U.S. Estate (and Generation-Skipping Transfer) Tax Return, for 2016. Of those filers, fewer than half — 5,219 estates — owed anything, paying $18.3 billion on assets of $108 billion, for an effective tax rate of 17 percent. Even among estates valued at more than $50 million, 133 managed to avoid paying any estate tax.

If the new exemption had been in place that year, it would have trimmed those estate-tax bills by an amount between $2.3 billion and $6.2 billion. No more than 2,204 estates would have exceeded the individual $10 million baseline exemption in 2016. And under the new $20 million baseline exclusion for married filers, the tax would have hit just 911 estates.

Besides the generous exemption, the estate tax always has provided another big benefit to inheritors: Those assets are passed on at their market value at the time of death. This allows stocks, real estate and other holdings that may have appreciated to be sold with no tax ever paid on those gains.

That’s the prime reason that anyone with an estate valued between the old and new exemption limits needs to consider rewriting his or her plan to bring the maximum amount of assets back into the estate. The problem is that one vehicle that’s often used is an irrevocable trust, which, as the name implies, isn’t easily reversed.

“Every estate planner has a handful of files where we now want to bring those assets back into the estate to get that step-up in basis, but it’s not that easy,” Jenney said. “We’ve got to petition the probate court, show that circumstances have changed, go to court and terminate the trust.”

Another time bomb in older estate plans could lurk in trusts that move assets out of the estate to future generations, called generation-skipping transfers. These transfers are taxed in coordination with the estate tax and gift tax and count toward the estate tax exemption amount. Often, those trusts use a formula that automatically removes the maximum exemption amount from the estate and places that money in the trust, said Melissa Langa, managing partner of Bove & Langa in Boston.

“If you had an $11 million estate before the new act, $5 million would go to the trust for future generations, $6 million would be held for the spouse, and that would have been a great plan,” Langa said. “Now it might be that all $11 million is held for the benefit of the children and grandchildren and the spouse is left with nothing.”

An added sting for families forced to rewrite their estate plans (a process that can cost between $2,000 and $10,000) is that unless the work is a business expense, they can’t deduct that cost. The new tax law eliminated the allowance for tax preparation fees.

But it’s the sunset provision of the new law that creates the most potential problems, according to estate planners, many of whom are unimpressed with the hasty, late-December tax-law rewrite.

“We’re lucky it’s as tame as it is, because the legislation is just idiotic,” said James Spica, an estate tax specialist with Dickinson Wright in Detroit. “I don’t think there even was a handful of people working on it who understand how it works.”

Spica pointed out that the estate of a spouse who died under the older, lower exemption would benefit if the surviving spouse died between now and the end of 2025. Estates of any amount pass untaxed to a spouse and are taxed only after the surviving spouse dies. So even if the first spouse died when the estate exemption was $11 million for a couple, that estate enjoys a $22 million exemption — but only if the surviving spouse dies before Dec. 31, 2025.

Meanwhile, someone who dies today under the $22 million exemption could see that allowance cut in half if the surviving spouse passes away in 2026, when the exemption drops to the earlier limit.

“You’ll get half the benefit if the second spouse dies outside this new regime,” Spica said.

Another issue Congress left hanging concerns how to handle gift taxes after the higher exemption expires. Because the tax on large gifts works in concert with the estate tax, the estate of someone who gives away more than the lower exemption could be hit with a “claw back” tax bill for several million dollars when the law reverts to the lower limit, said James Blase of Blase & Associates in St. Louis.

“If you make a very large gift before 2026 and die afterward, there’s absolutely no law,” Blase said. “Congress left it totally up to the IRS to issue regulations, and that’s a big deal. There’s a lot of uncertainty.”

The one place where estate-tax certainty does exist is within the very wealthiest families, who continue to face a 40 percent maximum tax rate on their estates.

“For the uber-wealthy, a $5 million change in the exemption doesn’t really make a difference,” Langa said, adding: “It’s a huge thing for people in the $10 million to $20 million range, but if you’re in the $200 million range, it’s a drop in the bucket.”

This article originally appeared in The New York Times.

Heirs inherit uncertainty with new estate tax

Despite repeated attempts by conservative lawmakers to kill it — and a 2016 campaign-trail vow by Donald Trump that “no family will have to pay the death tax” because “we will repeal it” — the estate tax remains a surprisingly resilient part of the U.S. tax code.

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