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How Current Tax Laws Can Impact Your Estate Planning

How Current Tax Laws Can Impact Your Estate Planning

24 Sep 2021

Estate planning does not occur in a vacuum. Tax laws are dynamic, meaning they have the potential to change quite significantly.  The dynamics of the United States’ tax laws can be evidenced by former President Trump’s signing of a new tax bill prior to his departure from public office. Previously referred to as the Tax Cuts and Job Act (TCJA), this law will have a considerable impact on estate planning as well as tax planning and overarching financial planning.

Tax Reform Changes

Tax law reform has increased the estate tax exemption all the way up to $11.18 million per individual.  The estate tax exemption has also increased to $22.36 million for married couples.  These hikes are considerable increases from previous limits.

The IRS has also stated the estate tax exemption for an individual is $11.58 million, meaning gifts to heirs that are below this cap will not be subject to federal estate taxes.  In short, the new tax law has shaped estate planning to a significant degree.  The law has essentially removed the federal estate tax for the vast majority of people.

Only those who have tens of millions of dollars will be subjected to federal estate taxation.  However, there is an exception that must be highlighted.  The new tax rules will expire on the last day of 2025.  At that point, the exemption amount will move back to prior levels after inflation is accounted for.

The GST Rate Exemption

GST is an acronym for Generation Skipping Tax. The GST is a tax on large estates, and it taxes each generation of the estate until the last generation. This tax is a federal law that allows for money to be passed from generation to generation within a family without accumulating taxes. This tax was created so that families could save money and pass it on to the next generation.

The GST helps ensure that more money is available to distribute to current generations because there is no longer a reason for people to tie up their assets and have them only going towards reducing future generations’ taxes.

Alterations to Methodology

The method used for calculating inflation on exemptions as well as related items has been altered. The Consumer Price Index (CPI) was used prior to the tax law change for such calculations.  Exemptions and inflation are now calculated in accordance with Chained-CPI.

This term refers to an altered gauge of inflation that accounts for variables such as situation bias and the alterations to consumer purchasing behavior.  The reliance on the Chained-CPI for such calculations nearly always results in a lower inflation rate.

 

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The Tax Laws’ Impact on Your Family’s Financial Situation

The exemptions for the GST and federal estate tax create about a half-decade window of opportunity to give away a significant amount of one’s estate to heirs without triggering estate taxes. The new law is also favored by beneficiaries as it sets the stage for them to receive that much larger of a financial gift.  However, these changes to tax laws do not mean individuals and families should forego estate planning.

Everyone should be aware of the fact that the estate tax was not repealed for states where it is assessed.  Those who live in certain states are still legally required to pay estate taxes pertaining to state law.  At the current moment, the following states impose estate tax laws:

  • New York
  • Washington
  • Maryland
  • Massachusetts
  • Maine
  • Minnesota
  • Connecticut
  • Hawaii
  • Illinois
  • Rhode Island
  • Vermont
  • Oregon
  • District of Columbia

Tax laws will continue to change in the years and decades ahead, meaning some states will be added to the list above while others may be gradually removed.

As an example, qualified terminable interest property (QTIP) trusts and/or a disclaimer and a bypass trust make estate planning that much more flexible in terms of asset allocation in the estate, ultimately reducing the amount of taxes paid.  Furthermore, it might be financially prudent to provide family members with financial gifts now while the federal estate tax is temporarily lifted to maximize the amount of money your loved ones receive from your estate.

life insurance for future generationsThe Strategic Use of Life Insurance

Life insurance policies are a common means of helping heirs pay estate taxes that might be owed as a result of the dissemination of a large estate. If such a sizable estate is valued beyond the caps noted above following the tax law changes, a life insurance policy might help cover the cost of related taxes. Moreover, proceeds from life insurance policies are generally not taxed.

Life insurance policies empower grantors to transfer assets with superior tax-efficiency and superior liquidity.  Some estate assets are not easily liquidated.  As an example, a stake in a business or a plot of land are illiquid assets that cannot always be quickly liquidated by heirs.

Recognize the Merits of SLATs

The Spousal Lifetime Access Trust, or SLAT for short, can protect your spouse’s financial interests. This irrevocable trust moves assets out of your estate, transferring them to an irrevocable trust for your spouse’s benefit.

The asset transfer ultimately results in a considerable tax savings thanks to the higher estate tax exemption between now and the end of the decade’s midway point in 2025 when the federal estate tax will likely be reimplemented.

Having a comprehensive financial plan matters a great deal since tax management can confusing. The grantee will not have any claim to the assets identified in the SLAT in the event of a couple’s divorce. Furthermore, if there are two separate SLATs for each spouse, they should not be exactly the same.

If the trusts were close to identical, there might be a meritorious argument to make that the reciprocal trust doctrine has been violated. If such a violation is proven, the trust is likely to be invalidated.

Consider the Advice of a CERTIFIED FINANCIAL PLANNER™ practitioner (CFP®)

Due to all the ins and outs of estate planning, speaking with a fee-only CFP® professional can help you decide which route is the safest and best for you.

There is something to be said about being able to sleep soundly knowing that a professional estate planner has thoroughly reviewed your financial situation, which includes your assets and any current estate plans you may have.

With the ability to provide holistic, fully customized planning with all the information you need to safeguard your assets, maintain a valid trust, while remaining compliant with tax laws.

This in-depth, detail-oriented professional financial planning ultimately provides your loved ones with the financial support necessary to live comfortably today and also across posterity.

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More About the Author: E. Michael McGervey, CFP®, CRPC®

Mike is passionate and skilled at helping clients solve complex financial challenges. He’s known for his thoughtful communication, educational approach, and exceptional customized service. Mike has been a sought-after source for financial television, magazines, and newspapers looking for insightful analysis. His expertise has been featured by CNBC, FOX Business and...