Year-End Tax Planning, Tax Reform and Proposed 2704 Regulations Withdrawn

Year-End Tax Planning

As 2017 comes to a close, we remind you to consider making gifts to minimize your potential estate tax liability. As you may recall, the federal estate tax rate is 40% and applies to the amount by which your estate exceeds your available exemption amount, so it is worth taking steps to reduce your potential liability. In 2017, the estate tax and gift tax exemption amounts are $5,490,000. In addition, estates valued at more than $1,000,000 will be subject to Massachusetts estate tax if the decedent was a resident of Massachusetts at his or her death. Massachusetts does not have a separate gift tax and therefore, lifetime gifts will reduce future Massachusetts estate tax liability.

In computing federal taxable gifts for any year, the first $14,000 of gifts (the “annual exclusion”) made to each individual donee is excluded as long as the gift is made directly to the donee or to a trust meeting certain technical requirements. These gifts must be completed (meaning checks must have cleared) by the end of the calendar year in order to qualify for that year’s annual exclusion. A married couple can exclude up to $28,000 of gifts to each donee in any year, regardless of which spouse actually makes the gift, by electing to “split” gifts on their gift tax returns. There is no limit on the number of donees for whom such annual exclusions can be claimed, nor is there any requirement that the donee be related to the donor. The annual exclusion can be a powerful tool allowing for transfers over time of substantial value at no gift tax consequence to the donor. Such annual exclusion gifts can be made directly to beneficiaries each year. For many donors who prefer the gifts to accumulate over time under the management of a trustee, however, gifts to certain kinds of qualified trusts may be a better option. If you have not already made annual exclusion gifts in 2017, now would be a good time to consider whether to do so.

Another way to reduce your estate and benefit your family is to make direct payments for tuition and medical expenses on their behalf. There is an unlimited gift tax exemption for certain payments made directly to the provider for educational expenses or medical expenses. In order to qualify for this exception, educational expenses must be limited to tuition only and must be paid directly to the education provider. Similarly, medical expenses must be for certain “qualified” medical expenditures that are not reimbursed by the recipient’s medical insurance. Again, such medical expense payments must be made directly to the provider. If you take advantage of the exclusion to pay educational and medical expenses on a person’s behalf, you may still utilize the annual exclusion in favor of the same person. This allows you to give substantially larger annual gifts, free of gift tax, to individuals who also have educational or medical needs.

Lifetime gifts to charity also result in tax savings for the donor. A charitable gift made during life is not only removed from your estate for tax purposes, but it also qualifies for an immediate federal income tax deduction, subject to certain limitations, at your marginal income tax rate. You get an immediate tax break in the year of the gift and will get a second break at death because the property given away will no longer be part of your estate. It is especially tax-effective to give appreciated marketable securities to a public charity, as you will not realize capital gains on the transfer to the charity, but you must comply with certain technical rules. If you would like to give assets other than cash or marketable securities, please contact your Goodwin attorney to discuss the tax implications of such a gift.

Gifts to individuals in excess of the annual exclusion also can be useful in reducing future estate tax liability. Such gifts which do not exceed your remaining federal exemption amount will not result in a current federal or Massachusetts gift tax liability. Even if you had previously given away the maximum amount allowed under prior law, you may still have additional exemption to use toward lifetime gifts due to the annual adjustments for inflation. Gifts may be made outright or to trusts for the benefit of your children and more remote descendants. Gifts in excess of your remaining federal exemption will generate a current federal gift tax liability, but subject to certain limitations, the payment of that tax also reduces the size of your estate for estate tax purposes, potentially resulting in additional tax savings; however, in light of the proposed tax reform, we generally do not advise making such gifts at this time.

If you are interested in making gifts to your children or grandchildren (or to qualifying trusts for their benefit) and/or charitable gifts, you should do so as soon as possible and must do so by the end of 2017 if you intend to take advantage of the annual exclusion from gift tax for 2017. We are happy to assist you in determining the best method for structuring such gifts.

2018 Exemption and Exclusion Amounts

Under current law, the 2018 unified federal estate and gift tax exemption amount increases to $5,600,000, as does the federal GST exemption amount ($11,200,000 for a married couple). The annual exclusion amount for gifts will rise to $15,000, the first increase since 2013. Of course, all of these exemptions and the structure and existence of the estate and generation-skipping taxes are subject to change if tax reform is signed into law.

The Massachusetts estate tax exemption remains at $1,000,000.

Proposed Federal Tax Reform

The House Republican tax plan, passed on November 16, includes the ultimate elimination of the estate tax and generation skipping transfer (“GST”) tax. In the short term, the House plan would double the exemption from the federal estate tax (currently $5.45 million per taxpayer and nearly $11 million for married couples) and repeal the tax entirely by 2024. The Senate Republican plan, released on November 9, also doubles the exemption but does not include provisions repealing the tax.

Neither plan includes repeal of the gift tax, which applies to transfers made during your lifetime. In addition, neither plan would make changes to the income tax provisions that allow heirs to use estate tax values rather than original cost values as their basis, essentially avoiding capital gains taxes upon a later sale of inherited assets.

The plans also propose changes to the following income tax provisions:

• Brackets
• Standard deduction
• Personal exemptions
• Family tax credits
• State and local tax deduction
• Mortgage interest deduction
• Alternative minimum tax

As of this writing, the next step is the passage of the Senate bill and, if that is successful, the consolidation of the two bills into a joint compromise bill to be signed by the President. It is the stated goal of the Republicans to have the bill to the President by the end of the year. We of course do not know in what form legislation will be passed, if at all. Please stay tuned for further developments on the future of the estate and gift tax.

Proposed 2704 Regulations Withdrawn

The U.S. Treasury has announced plans to formally withdraw proposed changes to IRC Section 2704 that were issued last fall and would have limited valuation discounts for minority interests and lack of control. These proposed changes were discussed in our September 22, 2016 client alert. Clients that would have been affected by these changes should be aware of this reversal.