Estate Planning Amid Potential Tax Increases

The Tax Cuts and Jobs Act (TCJA) increased the size of a non-taxable wealth transfer to a non-spouse from $5 million to $10 million. The $10 million amount was indexed for inflation such that in 2020 a tax-free estate is $11.58 million per person. 

TCJA also made the unused portion of the estate tax deduction of the first spouse to die “portable” to the estate of the survivor.

Assume a wealthy couple holding $23.16 million with the husband dying this year with an estate of $10 million. If the wife dies in 2022 her $13.16 million estate would be entitled a deduction of approximately $11.58 million, plus the $1.58 million unused deduction of her husband. No tax would be due.

OK, $23.16 million is plenty of coverage for the vast majority of Mahoning Valley family businesses. So what’s the problem?

When TCJA was passed, the Republicans did not have 60 Senate votes to override a Democratic filibuster, so a deal was cut that sunset the law in 2026. At sunset, portability will be lost, and a tax-free estate will be reduced to the amount under the old law – $5 million (plus an inflation adjustment). In this circumstance, the tax due on our hypothetical estate of $23.16 million would be over $7 million.

The country’s fiscal situation is precarious. The federal debt essentially doubled during the Obama administration, from $10.6 trillion to $20 trillion. Money-printing and big deficit spending continued with the Trump administration. Then came Covid-19 and its economic stimulus packages. As a result of all of these things, national debt held by the public is due to reach 100% of gross domestic product this year, a level last seen during World War II.  

If Congress isn’t likely to substantially cut spending, the reach will be for revenue, and quite possibly allowing the TCJA to expire at midnight Dec. 31, 2025.

Depending on the results of our upcoming election, the TCJA could simply be repealed if the Democratic Party captures 60 votes in the Senate. The Senate minority leader has threatened to revoke the 60-vote rule if he gains a mere 50 vote working majority. This creates stressful scenarios for business owners that should be considered in the near-term.

• Scenario One: TCJA survives through 2025 and then sunsets.  Good planning here dictates being prepared to make big gifts to the next generation (outright, or in trust) before the end of 2025.  

A question concerning the sunset of the law was whether amounts ported from one spouse to another over the $5 million exemption could be used after Jan. 1, 2026. Happily, the IRS issued a final regulation that said those who take advantage of the TCJA rules will not be hurt after the sunset occurs.

• Scenario Two: TCJA is repealed in 2021. Portability would likely be gone. Worse, the amount of a tax-free estate might be reduced below the old law’s $5 million amount to, say $3 million, or even less. If this unfolds, taxpayers would be wise to use trusts to efficiently capture transfer tax credits and deductions.  

Even having done this, our hypothetical couple would be crushed by gift and estate taxes and may want to buy life insurance to provide the liquidity to pay the 40% tax on the taxable portion of their estates.

Copyright 2020 The Business Journal, Youngstown, Ohio.