Summary of New 2018 Estate, Gift, and Generation Skipping Transfer Tax Law and Planning with Portability

The estate tax exemption has been doubled by The Tax Cuts and Jobs Act, which is the short name given to the new law by the Republicans. Technically, the official name is more like: H.R. 1: An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.

For 2018, the $5,000,000 estate tax exemption was scheduled to increase to $5,600,000 for a single person, but with the new law, it is now basically doubled, and is still inflation adjusted each year. However, the manner of calculating the inflation adjustment has been changed and will likely slow down the increase in the exemption.

This means that for 2018, the exemption is $11,180,000, per person. This also means that with portability, a married couple has a combined exemption of $22,360,000, again adjusted yearly for inflation. Portability requires filing an estate tax return upon the death of the first spouse, even if it is not otherwise required.

Although the surviving spouse’s exemption will be subject to further inflation adjustment, the predeceased spouse’s exemption will not be adjusted after his or her death. So, for instance, if a spouse dies in 2018, his or her exemption will be locked in at $11,180,000. However, the surviving spouse’s exemption will continue to be adjusted for inflation each year, so long as he or she is alive.

In order for portability to apply, although no tax or estate tax return may otherwise be due, a timely estate tax return must be filed for the estate of the predeceased spouse. Timely is nine (9) months after the date of death of the first spouse, which can be extended for an additional six (6) months.

Although a complete return is also due, in order to preserve the deceased spouse’s exemption, the IRS has eased the requirements somewhat in order to make it easier to file the estate tax return.  Ironically, the IRS is not requiring the valuation of certain items that qualify for the estate tax marital deduction. The reason for the irony is that many of the items must be valued, in any event, to calculate later capital gains and losses. For this reason, it may be good to value all assets, even if not required by the IRS. 

The estate tax return filed in this abbreviated manner is also subject to further review upon the death of the surviving spouse, for purposes of determining if the portability amount is correct.  Otherwise, the return would have been subject to the normal statute of limitations. 

What portability means, for example, is that if a spouse dies in 2018 or later and leaves all of his or her assets to their surviving spouse, the surviving spouse may use the predeceased spouse’s unused exemption upon the surviving spouse’s death. If the predeceased spouse leaves assets to some other beneficiary who is not a spouse or qualified charity, such as a child, the gift reduces the portable amount by the value of the gift or bequest.

Since the gift tax exemption is one and the same as the estate tax exemption, meaning the lifetime exemption is one unified exemption that can be used to reduce either estate or gift taxes, portability on the estate tax side may also allow larger lifetime or testamentary gifts by the surviving spouse. To be clear, the estate and gift tax exemption is only one exemption. If you reduce the gift tax exemption, you likewise reduce the estate tax exemption. For this reason, you have to be careful making lifetime gifts since they also reduce the estate tax exemption. 

With both estate and gift taxes, the issues become much more complex if there is a subsequent marriage after the death of the first spouse. The exemption of the first spouse to die can be lost upon remarriage. This is because you can only use the exemption of the most recently deceased spouse and the new spouse may not have his or her own full exemption, if they made substantial previous gifts. If the new spouse predeceases, then the exemption of the first predeceased spouse will be lost because the new spouse becomes the most recently deceased spouse for purposes of determining the Deceased Spouse’s Unused Exemption Amount, also called DSUEA and/or DSUE

However, there are ways for a surviving spouse to use the first predeceased spouse’s exemption during the life of the new spouse by making gifts. The gifts are charged, first, against the predeceased spouse’s exemption. If the second spouse has his or her own exemption and predeceases, the surviving spouse can effectively use the exemption of both spouses. 

In our example, assuming all 2018 exemptions, it is possible for a very wealthy spouse to pick up a total of $36,600,000 in estate tax exemptions. This is his or her own exemption ($11,180,000) plus the first deceased spouse’s exemption ($11,180,000), with lifetime gifts, plus the second predeceased spouse’s unused exemption (either through making lifetime gifts or at death). 

The exemption amount of an individual may become a significant issue in negotiating premarital agreements between couples and may cause some to think twice before getting married, especially if one of them has used up his or her exemption. This may also cause “shopping” for a spouse in order to use their exemption. 

Keep in mind that a mere $5,000,000 exemption can be worth as much as $2,000,000 in estate tax savings. Oddly, this can make someone with modest means, who is substantially older and in very poor health, an attractive candidate for marriage to a wealthy spouse. Once an individual gets above the $11,180,000 amount for 2018, at a 40% estate tax rate, the extra exemption of the spouse with modest means can be worth up to $4,472,00 to the wealthy spouse. All this discussion is ignoring state estate and gift taxes, but South Carolina and many other states no longer have estate and gift taxes, including Florida where we also practice. 

In the above example of a spouse who survived his or her first two spouses, the spouse picks up another $4,472,000, per spouse, in tax savings, for a total of up to $8,944,000. Adding in the spouse himself or herself, there is another $4,472,000, for a total estate tax savings of up to $13,416,000. There are also methods of leveraging the gifts and saving even more taxes.  Obviously, this is a strategy for the very rich, since most married couples do not have taxable estates of over $11,180,000 and will not need the portability of DSUEA/DSUE. 

However, on December 31, 2025, the estate tax exemption will “sunset”, meaning expire, and go back to the old limits, which will effectively reduce it by one-half (1/2), but still with the inflation adjustment. It should be noted that the favorable income tax rates will also sunset on December 31, 2025. This likely means that the expiration of the income tax rate cuts for the middle class will be used as leverage by the Republicans to keep the estate, gift, and generation skipping transfer tax exemption amounts or increase them. 

In some cases, the new estate tax exemption, even without further increases, can save a married couple nearly $9,000,000 in estate taxes, as discussed above. Also, with proper planning, this can be leveraged. 

Also keep in mind that certain lifetime gifts also reduce the exemption amount. Both gift taxes and estate taxes share the same exemption amount. However, present interest gifts of not more than the annual exclusion amount from gift taxes do not reduce the exemption amount. 

Currently, the annual exclusion amount is $15,000, per donee, per year, for present interest gifts. It is also adjusted annually for inflation. With proper planning, this allows large amounts to be gifted out of an estate, both estate and gift tax free. 

Proper present interest gifts within the limits do not require filing a gift tax return and there is no loss of the lifetime exemption. Annual gifts in excess of $15,000 per donee will require filing a gift tax return and also use of the lifetime exemption for the amounts over $15,000, per donee.  

A gift tax return is also required when one spouse makes his or her own gift and wants to treat it as made one-half (1/2) by each spouse in order to use each spouse’s annual exclusion and possibly part of each of their exemption amounts. 

The generation skipping transfer tax exemption amount is the same as for estate taxes with important differences. It is not shared with the gift and estate tax exemption and there is no portability. For this reason, caution needs to be observed with respect to how it is used. 

Overall, the new tax act is favorable as far as reducing estate, gift, and generation skipping transfer taxes. However, due the sunset provisions, it will make it somewhat more difficult to plan for high net wealth taxpayers who may live past 2025. However, even the lower $5,600,000 personal exemption with portability benefits the vast majority of decedents.