This article is the third in a 3-part series concerning the implications and consequences of the Tax Reform Act recently passed by Congress. Part I focused on individual taxpayers; Part II focused on businesses; and Part III focuses on the planning considerations for high net worth individuals.
As we discussed in earlier installments of this series, Congress recently passed the largest piece of tax reform legislation in more than 30 years. Though this bill will likely affect most individual taxpayers in one way or another, there are exceptionally beneficial opportunities for high net worth individuals, and they would be wise to take full advantage of them while they can.
It is important to understand that many of the new tax reforms are set to expire in 2026. Also important it is entirely possible that a new Administration or a new Congress could conceivably undo many of these existing revisions and make their own alterations to the tax code. So, it behooves high net worth individuals to reexamine and refine their planning now and make adjustments to appropriately maximize the favorable opportunities that are currently available to them.
Of course, every situation is unique but all high net worth individuals would be wise to consult with their team – generally a financial planner, an accountant and an attorney – who understand their client’s specific goals and circumstances. Then proper recommendations and adjustments can be initiated to effect the best possible outcome on their behalf.
Let’s look now at some specific provisions of the new tax reform act and how high net worth individuals might benefit from them:
Gift and Estate Tax Exclusion
It is likely that the most impactful reforms in the new tax act for high net worth individuals are the changes that have been made to the wealth transfer tax system. The federal estate, gift and generation-skipping transfer (GST) tax exemption amounts have been increased to $11,200,000 for individuals (previously $5,490,000) and $22,400,000 for married couples (previously $10,980,000). This significant increase in the exemption amounts presents a unique opportunity for estate planning. These increased amounts allow individuals or married couples to transfer financial gifts to their children and/or grandchildren, either outright or to new and existing trusts, without the imposition of a federal gift tax.
These increased exemption amounts are scheduled to sunset on January 1, 2026 but as I mentioned above, it’s possible they could be reduced before then by future legislation. Therefore, high net worth individuals should consider implementing strategic gifting plans now to take advantage of the present exclusion amounts while they exist.
Gifting during your lifetime has another non-monetary benefit. It affords you the opportunity to see how your beneficiaries handle money and to adjust course as needed.
Wills and Revocable Trusts
Another consequence of the increased exemption amounts pertains to existing Wills and Revocable Trusts. Often, many Wills and Revocable Trusts create trusts that will be funded according to formula clauses tied to the exemption amount in effect on the date of death. Under the current law, these trusts may be funded with significantly larger amounts than what may have been anticipated when the documents were signed, should the trust’s originator die before 2026. As a result, it is recommended that individuals review the terms of their Wills and Revocable Trusts to ensure they remain in accordance with their wishes. Absent this review a loved one or charity could receive far less or more than desired.
Annual Exclusion Gifts: Beginning in 2018, individuals and married couples are also able to give annual gift amounts to an unlimited number of recipients without incurring a gift tax and without using any of their gift tax exemption amount. For individuals the amount is $15,000; for married couples the amount is $30,000. In other words, a married couple may make annual exclusion gifts up to a total of $30,000 to as many people as they would like without incurring a gift tax.
Life Insurance as a Tax Hedge: Given the uncertainty of what income taxes will be some high net worth individuals might want to consider diverting some of their income, dividends or excess gains into permanent life insurance in order to generate a tax hedge. Increases in the cash value of an insurance policy are not currently taxable, and distributions to basis and loans can be accessed tax free. In addition, the policy beneficiaries would also be the recipient of a tax free death benefit in the wake of a client’s unexpected passing.
Shifting Family Businesses to the Next Generation: Because of the increased gift exemptions, this is an auspicious time to shift businesses to the next generation. However, senior generations are often reluctant to give up control. In that case, those senior individuals might choose to recapitalize the company and gift non-voting shares to their younger family members. This allows the senior generation to maintain control, while still minimizing estate tax exposure.
Asset Protection: Assets gifted now to an irrevocable trust can be protected from future creditors. By utilizing trusts and loans that are specifically designed for this purpose, assets can be reclaimed in the future if there is a need to access them. These trust can also afford credit protection for the beneficiaries when properly structured.
Insurance for Real Estate Investors: Many high net worth individuals have accumulated substantial wealth in the real estate market in recent years. However, this might pose tax and liquidity problems in the future. Often these assets are depreciated. Due to Step-to-Basis, at death the basis for the beneficiary becomes its value at death of the grantor, there is a benefit to retain real estate within the estate. The down side is this being kept in the estate also inflates the estate and any tax due.
One solution is to use their current gift capacity to purchase life insurance as a means to offset their future income and/or estate tax liabilities.
In closing, with the new tax reform and through proper financial planning, high net worth individuals are fortuitously positioned to take advantage of genuine opportunities to mitigate their estate taxes in the future and assure their wishes are met.
Postscript: Though this article concludes our series, please be on the lookout for a future article that will address the financial planning needs of those people who are not in the high net worth category, and who are not presently concerned with estate tax issues. The article will detail the kind of legacy and financial planning those individuals might choose to consider.