Checkpoint Special Study on Estate and Gift Tax Changes in the “Tax Cuts and Jobs Act”
Checkpoint Special Study on Estate and Gift Tax Changes in the “Tax Cuts and Jobs Act”
On December 22, President Trump signed into law H.R. 1, the “Tax Cuts and Jobs Act,” a sweeping tax reform law that promises to entirely change the tax landscape.
While the final version of the legislation carries the title “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” this article refers to the Act by its former and commonly used name: The “Tax Cuts and Job Act.”
This article describes the Act’s estate and gift tax changes, including the increased exemption amount for the estate and gift tax, the new rates and brackets, and modification of the kiddie tax.
RIA observation: One of the major distinctions between the House and Senate versions of the tax bill was that the Senate bill, in order to comply with certain budgetary constraints, contained a “sunset,” or an expiration date, for many of its provisions—e.g., they apply for tax years beginning before January 1, 2026. Accordingly, many of the individual tax provisions in the Act are temporary (as opposed to the business provisions, which generally are permanent). Meeting these budget constraints is key as it allows the Senate to pass the bill under reconciliation procedures, meaning that only a bare majority vote is required instead of the 60-vote threshold that typically applies, which in this case means without bipartisan support. As the Senate continues to be subject to these budgetary constraints, these “sunsets” generally made it into the Conference Committee’s reconciled version of the bill.
Estate and Gift Tax Retained, with Increased Exemption Amount
Under pre-Act law, the first $5 million (as adjusted for inflation in years after 2011) of transferred property was exempt from estate and gift tax. For estates of decedents dying and gifts made in 2018, this “basic exclusion amount” was $5.6 million ($11.2 million for a married couple).
New law. For estates of decedents dying and gifts made after December 31, 2017 and before January 1, 2026, the Act doubles the base estate and gift tax exemption amount from $5 million to $10 million. (Code Sec. 2010(c)(3), as amended by Act Sec. 11061(a)) The $10 million amount is indexed for inflation occurring after 2011, and is expected to be approximately $11.2 million in 2018 ($22.4 per married couple).
RIA observation: The language in the Act does not mention generation-skipping transfers, but because the generation-skipping transfer tax exemption amount is based on the basic exclusion amount, generation-skipping transfers will also see an increased exclusion amount.
New Income Tax Rates & Brackets
To determine regular tax liability, an individual uses the appropriate tax rate schedule (or IRS-issued income tax tables for taxable income of less than $100,000). The Code provides four tax rate schedules for individuals based on filing status—i.e., single, married filing jointly/surviving spouse, married filing separately, and head of household—each of which is divided into income ranges which are taxed at progressively higher marginal tax rates as income increases. Under pre-Act law, individuals were subject to six tax rates: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
New law. For tax years beginning after December 31, 2017 and before January 1, 2026, seven tax brackets apply for individuals: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The Act also provides four tax brackets for estates and trusts: 10%, 24%, 35%, and 37%. (Code Sec. 1(i), as amended by Act Sec. 11001) The specific application of these brackets, and the income levels at which they apply, is shown below.
FOR ESTATES AND TRUSTS: If taxable income is: The tax is: --------------------- ----------- Not over $2,550 10% of taxable income Over $2,550 but not $255 plus 24% of the over $9,150 excess over $2,550 Over $9,150 but not $1,839 plus 35% of the over $12,500 excess over $9,150 Over $12,500 $3,011.50 plus 37% of the excess over $12,500
FOR MARRIED INDIVIDUALS FILING JOINT RETURNS AND SURVIVING SPOUSES: If taxable income is: The tax is: -------------------- ----------- Not over $19,050 10% of taxable income Over $19,050 but not $1,905 plus 12% of the over $77,400 excess over $19,050 Over $77,400 but not $8,907 plus 22% of the over $165,000 excess over $77,400 Over $165,000 but not $28,179 plus 24% of the over $315,000 excess over $165,000 Over $315,000 but not $64,179 plus 32% of the over $400,000 excess over $315,000 Over $400,000 but not $91,379 plus 35% of the over $600,000 excess over $400,000 Over $600,000 $161,379 plus 37% of the excess over $600,000
FOR SINGLE INDIVIDUALS (OTHER THAN HEADS OF HOUSEHOLDS AND SURVIVING SPOUSES): If taxable income is: The tax is: -------------------- ---------- Not over $9,525 10% of taxable income Over $9,525 but not $952.50 plus 12% of the over $38,700 excess over $9,525 Over $38,700 but not $4,453.50 plus 22% of the over $82,500 excess over $38,700 Over $82,500 but not $14,089.50 plus 24% of the over $157,500 excess over $82,500 Over $157,500 but not $32,089.50 plus 32% of the over $200,000 excess over $157,000 Over $200,000 but not $45,689.50 plus 35% of the over $500,000 excess over $200,000 Over $500,000 $150,689.50 plus 37% of the excess over $500,000
FOR HEADS OF HOUSEHOLDS: If taxable income is: The tax is: -------------------- ----------- Not over $13,600 10% of taxable income Over $13,600 but not $1,360 plus 12% of the over $51,800 excess over $13,600 Over $51,800 but not $5,944 plus 22% of the over $82,500 excess over $51,800 Over $82,500 but not $12,698 plus 24% of the over $157,500 excess over $82,500 Over $157,500 but not $30,698 plus 32% of the over $200,000 excess over $157,500 Over $200,000 but not $44,298 plus 35% of the over $500,000 excess over $200,000 Over $500,000 $149,298 plus 37% of the excess over $500,000
FOR MARRIEDS FILING SEPARATELY: If taxable income is: The tax is: -------------------- ---------- Not over $9,525 10% of taxable income Over $9,525 but not $952.50 plus 12% of the over $38,700 excess over $9,525 Over $38,700 but not $4,453.50 plus 22% of the over $82,500 excess over $38,700 Over $82,500 but not $14,089.50 plus 24% of the over $157,500 excess over $82,500 Over $157,500 but not $32,089.50 plus 32% of the over $200,000 excess over $157,500 Over $200,000 but not $45,689.50 plus 35% of the over $300,000 excess over $200,000 Over $300,000 $80,689.50 plus 37% of the excess over $300,000
Kiddie Tax Modified
Under pre-Act law, under the “kiddie tax” provisions, the net unearned income of a child was taxed at the parents’ tax rate if the parents’ tax rate was higher than the tax rate of the child. The remainder of a child’s taxable income (i.e., earned income, plus unearned income up to $2,100 (for 2018), less the child’s standard deduction) was taxed at the child’s rates. The kiddie tax applied to a child if: (1) the child had not reached the age of 19 by the close of the tax year, or the child was a full-time student under the age of 24, and either of the child’s parents was alive at such time; (2) the child’s unearned income exceeded $2,100 (for 2018); and (3) the child did not file a joint return.
New law. For tax years beginning after December 31, 2017, the taxable income of a child attributable to earned income is taxed under the rates for single individuals, and taxable income of a child attributable to net unearned income is taxed according to the brackets applicable to trusts and estates (see above). This rule applies to the child’s ordinary income and his income taxed at preferential rates. (Code Sec. 1(j)(4), as amended by Act Sec. 11001(a))
Capital Gains Provisions Conformed
The adjusted net capital gain of a noncorporate taxpayer (e.g., an individual) is taxed at maximum rates of 0%, 15%, or 20%.
Under pre-Act law, the 0% capital gain rate applied to adjusted net capital gain that otherwise would be taxed at a regular tax rate below the 25% rate (i.e., at the 10% or 15% ordinary income tax rates); the 15% capital gain rate applied to adjusted net capital gain in excess of the amount taxed at the 0% rate, that otherwise would be taxed at a regular tax rate below the 39.6% (i.e., at the 25%, 28%, 33% or 35% ordinary income tax rates); and the 20% capital gain rate applied to adjusted net capital gain that exceeded the amounts taxed at the 0% and 15% rates.
New law. The Act generally retains present-law maximum rates on net capital gains and qualified dividends. It retains the breakpoints that exist under pre-Act law, but indexes them for inflation using C-CPI-U in tax years after December 31, 2017. (Code Sec. 1(j)(5)(A), as amended by Act Sec. 11001(a))
For 2018, the 15% breakpoint is: $77,200 for joint returns and surviving spouses (half this amount for married taxpayers filing separately), $51,700 for heads of household, $2,600 for trusts and estates, and $38,600 for other unmarried individuals. The 20% breakpoint is $479,000 for joint returns and surviving spouses (half this amount for married taxpayers filing separately), $452,400 for heads of household, $12,700 for estates and trusts, and $425,800 for other unmarried individuals. (Code Sec. 1(h)(1), as amended by Act Sec. 11001(a)(5))
New Measure of Inflation Provided
Tax bracket amounts, standard deduction amounts, personal exemptions, and various other tax figures are annually adjusted to reflect inflation. Under pre-Act law, the measure of inflation was CPI-U (Consumer Price Index for all urban customers).
New law. For tax years beginning after December 31, 2017 (Dec. 31, 2018 for figures that are newly provided under the Act for 2018 and thus won’t be reset until after that year, e.g., the tax brackets set out above), dollar amounts that were previously indexed using CPI-U will instead be indexed using chained CPI-U (C-CPI-U). (Code Sec. 1(f), as amended by Act Sec. 11002(a)) This change, unlike many provisions in the Act, is permanent.
RIA observation: In general, chained CPI grows at a slower pace than CPI-U because it takes into account a consumer’s ability to substitute between goods in response to changes in relative prices. Proponents for the use of chained CPI say that CPI-U overstates increases in the cost of living because it doesn’t take into account the fact that consumers generally adjust their buying patterns when prices go up, rather than simply buying an item at a higher price.
Charitable Contribution Deduction Limitation Increased
The deduction for an individual’s charitable contribution is limited to prescribed percentages of the taxpayer’s “contribution base.” Under pre-Act law, the applicable percentages were 50%, 30%, or 20%, and depended on the type of organization to which the contribution was made, whether the contribution was made “to” or merely “for the use of” the donee organization, and whether the contribution consisted of capital gain property. The 50% limitation applied to public charities and certain private foundations.
No charitable deduction is allowed for contributions of $250 or more unless the donor substantiates the contribution by a contemporaneous written acknowledgment (CWA) from the donee organization. Under Code Sec. 170(f)(8)(D), IRS is authorized to issue regs that exempt donors from this substantiation requirement if the donee organization files a return that contains the same required information. However, IRS has decided not to issue such donee reporting regs.
New law. For contributions made in tax years beginning after December 31, 2017 and before January 1, 2026, the 50% limitation under Code Sec. 170(b) for cash contributions to public charities and certain private foundations is increased to 60%. (Code Sec. 170(b)(1)(G), as added by Act Sec. 11023) Contributions exceeding the 60% limitation are generally allowed to be carried forward and deducted for up to five years, subject to the later year’s ceiling.
And, for contributions made in tax years beginning after December 31, 2016, the Code Sec. 170(f)(8)(D) provision—i.e., the donee-reporting exemption from the CWA requirement—is repealed. (Former Code Sec. 170(f)(8)(D), as stricken by Act Sec. 13705)
ABLE Account Changes
ABLE Accounts under Code Sec. 529A provide individuals with disabilities and their families the ability to fund a tax preferred savings account to pay for “qualified” disability related expenses. Contributions may be made by the person with a disability (the “designated beneficiary”), parents, family members, or others. Under pre-Act law, the annual limitation on contributions is the amount of the annual gift-tax exemption ($14,000 in 2017).
New law. Effective for tax years beginning after the enactment date and before January 1, 2026, the contribution limitation to ABLE accounts with respect to contributions made by the designated beneficiary is increased, and other changes are in effect as described below. After the overall limitation on contributions is reached (i.e., the annual gift tax exemption amount; for 2018, $15,000), an ABLE account’s designated beneficiary can contribute an additional amount, up to the lesser of (a) the federal poverty line for a one-person household; or (b) the individual’s compensation for the tax year. (Code Sec. 529A(b), as amended by Act Sec. 11024(a))
Saver’s credit eligible. Additionally, the designated beneficiary of an ABLE account can claim the saver’s credit under Code Sec. 25B for contributions made to his or her ABLE account. (Code Sec. 25B(d)(1), as amended by Act Sec. 11024(b))
Recordkeeping requirements. The Act also requires that a designated beneficiary (or person acting on the beneficiary’s behalf) maintain adequate records for ensuring compliance with the above limitations. (Code Sec. 529A(b)(2), as amended by Act Sec. 11024(a))
For distributions after the date of enactment, amounts from qualified tuition programs (QTPs, also known as 529 accounts; see below) are allowed to be rolled over to an ABLE account without penalty, provided that the ABLE account is owned by the designated beneficiary of that 529 account, or a member of such designated beneficiary’s family. (Code Sec. 529(c)(3), as amended by Act Sec. 11025) Such rolled-over amounts are counted towards the overall limitation on amounts that can be contributed to an ABLE account within a tax year, and any amount rolled over in excess of this limitation is includible in the gross income of the distributee.
Expanded Use of 529 Account Funds
Under pre-Act law, funds in a Code Sec. 529 college savings account could only be used for qualified higher education expenses. If funds were withdrawn from the account for other purposes, each withdrawal was treated as containing a pro-rata portion of earnings and principal. The earnings portion of a nonqualified withdrawal was taxable as ordinary income and subject to a 10% additional tax unless an exception applied.
“Qualified higher education expenses” included tuition, fees, books, supplies, and required equipment, as well as reasonable room and board if the student was enrolled at least half-time. Eligible schools included colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education. This included nearly all accredited public, nonprofit, and proprietary (for-profit) postsecondary institutions.
New law. For distributions after December 31, 2017, “qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school, and various expenses associated with home school, up to a $10,000 limit per tax year. (Code Sec. 529(c)(7), as added by Act Sec. 11032(a))
Charitable Contribution Deduction for ESBTs
Under pre-Act law, the deduction for charitable contributions applicable to trusts, rather than the deduction applicable to individuals, applied to an electing small business trust (ESBT). Generally, a trust is allowed a charitable contribution deduction for amounts of gross income, without limitation, which pursuant to the terms of the governing instrument are paid for a charitable purpose. No carryover of excess contributions is allowed. An individual is allowed a charitable contribution deduction limited to certain percentages of adjusted gross income, generally with a five-year carryforward of amounts in excess of this limitation.
New law. For tax years beginning after December 31, 2017, the Act provides that the charitable contribution deduction of an ESBT is not determined by the rules generally applicable to trusts but rather by the rules applicable to individuals. Thus, the percentage limitations and carryforward provisions applicable to individuals apply to charitable contributions made by the portion of an ESBT holding S corporation stock. (Code Sec. 641(c), as amended by Act Sec. 13542)