United States

Estate planning subsequent to the enactment of tax reform


The Tax Cuts and Jobs Act (TCJA) increased the lifetime estate, gift, and generation-skipping transfer tax exemption amounts to $11.18 million per taxpayer, in essence a doubling all transfer tax exemption thresholds. Under the new law, however, the doubling of the exemption amounts sunsets at the end of seven years. Nevertheless, if political power shifts, estate, gift, and generation-skipping transfer tax law changes could materialize sooner. The prospect of exemptions decreasing or major income tax changes at a future point in time, means that taxpayers need to consult their tax advisors to develop an estate plan flexible enough to utilize the current larger exemption amounts but is also sufficiently functional regardless of the laws in effect at death.

While the permanency of current exemption amounts and tax rates is subject to the vagaries of the political process, strategies exist to minimize future estate, gift and generation-skipping taxes for estates in excess of the existing exemption. This article explores tips and traps associated with estate planning strategies to consider.

Strategy 1 – Use it or lose it

Tip: The TCJA instructs the Treasury Department to develop regulations as necessary to address any difference in the basic exclusion amount. Without new guidance, it is possible that a prior gift covered by the gift tax exclusion at the time of the gift could theoretically result in tax, if the basic exclusion was decreased by the time of the donor’s death. This concept is often called ‘clawback.’ A similar phenomenon could also occur with the deceased spouse unused exclusion (DSUE) amount, that is ‘ported’ from the first deceased spouse to the surviving spouse.

Differences in exclusion amounts could be problematic. Most commentators are taking Treasury at its word and assuming that the requisite adjustments will be made at death so that no clawback occurs. Even without the threat of decreasing exemption amounts, taxpayers with taxable estates should take advantage of the increased exemptions and consider making gifts of appreciating assets now. Taxpayers reluctant to part completely with assets can use so-called estate freezes to transfer the appreciation of assets to trusts for the benefit of their heirs. Well known estate freeze techniques include sales to defective trusts and grantor retained annuity trusts (GRATs). Net gifts where the donee pays the gift tax should be considered for large gifts. Defined-value clauses, which shift the tax burden if values are changed on audit, should also be evaluated by donors.

Trap: With large gifts, whether taxable or designed to match the donor’s current remaining exemption amount, two concerns should be reviewed:

1.    The first issue is the appropriate discounts for gifts of closely held business assets. Some estate and gift attorneys are reporting increased IRS challenges to discounts. It may be that having lost its battle to police discounts with the Section 2704(b) proposed regulations, which were withdrawn last year by Treasury, the IRS is looking more closely at the business valuations submitted and taking exception to the discounts claimed for lack of control and lack of marketability.

2.    The other issue in play for some taxpayers is the three-year rule. Under the three-year rule, certain gift tax paid within three years of the donor’s death is included in the donor’s gross estate.

Strategy 2 – Business succession planning that minimizes estate taxes

Tip: Optimal estate planning for taxpayers who own business assets involves transferring non-controlling interests in those assets to trusts for family members, allowing the appreciation and sale proceeds to be received outside of the taxpayers’ taxable estate. Ideally, these transfers precede the sale or significant growth by years. GRATs, sales to defective grantor trusts and restructuring of businesses to create voting and non-voting shares are strategies with proven track records of minimizing estate taxes on heirs and transferring ownership of business assets to children and grandchildren working in the family business. Timing is everything. TCJA has been a windfall for many companies actively looking for acquisitions. The private equity and hedge fund markets are also very lively.  

Trap: Failing to plan for payment of capital gains taxes. Whether the client opts to use a GRAT or a sale to a defective grantor trust to transfer business assets to heirs, the income tax profile is the same. The trustor is deemed to own the transferred assets for income tax purposes and would owe the capital gain taxes if the business is sold either during the GRAT term or while the grantor trust is in existence. Planning ahead to ensure that the grantor has sufficient liquidity to pay the capital gain taxes should be a key component of the business succession planning and strategy.

Strategy 3 – Situs planning for irrevocable trusts

Tip: Taxpayers should consider relocating irrevocable family trusts to states without an income tax or with lower income tax rates than their resident state. Each state has a different definition of a resident trust. Some state laws allow grantors to relocate trusts easily. Avoiding tax under other state laws is complicated or in some cases, forbidden. Recent taxpayer victories in Pennsylvania, New Jersey, Illinois, North Carolina and Ohio are encouraging other taxpayers to consider relocating family trusts. Taxpayers in these cases successfully argued that the state taxation scheme violated the U.S. Constitution.

Relocating trusts can be accomplished through decanting or trust merger or in some cases simply by having the trustee declare the trust has been moved. In some instances, this planning can be combined with planning designed to ensure a state income tax deduction for the irrevocable trust.

Trap: Some states, such as California and New York, have aggressively pursued taxpayers who relocated family trusts to avoid state taxation. While the new case law is helpful, taxpayers seeking to challenge the status quo will need to be prepared for a fight with the state taxing authority.

Strategy 4 – Marital planning with formula clauses and utilizing portability

Tip: Estate planning documents drafted prior to 2011 should be reviewed to account for portability as well as the higher exemption amounts ushered in by TCJA. Portability is the ability of the first deceased spouse to transfer his or her DSUE to his or her surviving spouse. One complexity of estate planning in 2018 is deciding how to make optimal use of portability. The primary advantages of portability are simplicity and the ability of the surviving spouse’s estate to get a second basis step-up on estate assets. In considering how and whether to use portability, there are a number of factors to consider, including the surviving spouse’s age and life expectancy, the classes and location of assets, whether assets will likely be sold by the surviving spouse or held long-term, state estate taxes, the family’s comfort with trust planning, and the income tax brackets of the spouse’s heirs. Another approach involves blending trust planning with outright spousal bequests. One such example is planning that transfers all assets to the surviving spouse but then has the survivor use some or all of the DSUE to make gifts to children and grandchildren, typically in trust. 

Trap: Married couples residing in a state with a separate estate tax should consider using a by-pass trust or a disclaimer trust to create a trust at the first death, using the amount that can be excluded from state estate taxes to fund the trust, thereby ensuring that the state exemption amount of the first spouse to die is not lost. Married couples may prefer a structure where outright transfers of the personal residence and retirement plan assets are made to the survivor in combination with a two-trust plan that

1.    Funds a by-pass trust with the amount necessary to eliminate all state estate taxes on the first death

2.    Funds a marital trust with the balance of assets.

Formula clauses must be revisited to ensure the intent of the trustor is consistent with the language in the documents. For example, a married taxpayer with a $10 million estate could end up not providing for his or her spouse if the will instructs the executor to fund a marital trust with the amount necessary to eliminate federal estate taxes while leaving the balance to children. Since a marital trust would not be needed to eliminate federal estate taxes on the first death, (presuming the taxpayer had made no lifetime gifts) the $10 million could end up passing outright to children from a first marriage and disinheriting the surviving spouse. These clauses should also be reviewed from an income tax perspective. If, during a period of estate administration, assets appreciate and are then used to fund a pecuniary gift, the estate will owe capital gains taxes as the funding is treated as a sale.

Strategy 5 – Expanded 529 planning

Tip: TCJA modifies Code Section 529 to include expenses and tuition for K-12 education. This means that 529 accounts can now be used to pay for private or religious high school, middle school and elementary school. The payments are limited to $10,000 per student during any taxable year. Earnings in 529 plans grow tax free and are not taxed when funds are withdrawn to pay tuition and certain expenses set forth in the statute.

Trap: Not all states with state income taxes offer a full or partial tax deduction or credit for 529 plan contributions. Donors are permitted to fund a 529 plan with up to five years of contributions in one year. Since the annual exclusion has now increased to $15,000 per donee, married donors can now gift $150,000 ($15,000 per year over five years from each spouse) to a 529 account for a beneficiary without incurring gift tax. To make the five-year election, the donor must complete and file a gift tax return. During that five-year period, the donor cannot make additional annual exclusion gifts to that beneficiary without using their lifetime exemption.

Strategy 6 – Qualified personal residence trusts

Tip: Qualified personal residence trusts (QPRTs) allow taxpayers to transfer ultimate ownership of a residence to their heirs (or into a trust for their heirs) at a discounted gift tax value. Under this strategy, the taxpayer(s) contribute their residence to a trust for a term of years (typically seven to 15) and pay gift tax (or apply their applicable exemption amount) only on the value of the remainder interest in the trust. The value of the remainder is based on the taxpayer’s age and the interest rate used by the IRS to calculate present value. During the term, the residence is administered as usual. The taxpayer pays the property taxes and maintenance expenses and continues to reside in the residence. If the taxpayer dies during the term of the QPRT, the residence reverts to the taxpayer’s estate.

Trap: If the taxpayer survives the term, he or she must pay fair market value rent to either the remainder trust or directly to the heirs, depending on how the QPRT was designed. The best-constructed QPRT documents include a sample lease to ensure this significant QPRT feature is not overlooked or forgotten. The impact of a divorce should also be considered.

Strategy 7 – Incapacity planning

Tip: While working on funding and designing your revocable trust, be sure to plan for incapacity. If a revocable trust holds business assets and the settlor of the revocable trust becomes disabled, the successor trustee could then step in, manage the business assets, and use the trust funds to pay for the settlor’s care as well as the maintenance and support of any dependents.

Trap: If business assets are held outside of a trust, a power of attorney should be executed that makes specific provision for the management of business assets by empowering an agent to run your business if you become incapacitated.

Strategy 8 – Controlling the family limited partnership

Tip: Family limited partnerships (FLPs) and family limited liability companies (FLLCs) offer the opportunity to reduce estate taxes by making gifts or bequests of limited partnership interests (or membership interests) that are discounted to reflect their inherent lack of marketability and lack of control. Family partnerships, moreover, offer families the opportunity to create a single entity and consolidate ownership of various investments, including interests in other partnerships, alternative investments, real estate and marketable securities. FLPS are also good choices for holding voting blocks in publicly traded securities. FLPS allow centralized management and powerful creditor protection for family assets.

Trap: The issue of whether the taxpayer can retain control over the general partner and still avoid estate tax inclusion is murky under the case law. The Supreme Court decision in U.S. versus Byrum, stands for the proposition that control” in a fiduciary capacity does not cause inclusion under the retained rights or retained interest prohibitions in the Code. But a string of bad facts cases has muddied the water, beginning with Estate of Strangi, which involved four decisions, two in the Tax Court and two in the Fifth Circuit and continuing up to the recent en banc decision in Estate of Powell.  

One example of this case law is Turner v. Commissioner. In Turner, the decedent and his wife transferred marketable securities and investment assets to a family limited partnership and remained the general partner. The Tax Court ruled that there was an express and implied agreement for retained enjoyment of the transferred assets under section 2036(a)(1). Even though the court had already found inclusion under section 2036(a)(1), the court still went ahead and found that section 2036(a)(2) was applicable. The court viewed the decedent as effectively being the sole general partner and having

  1. The sole and absolute discretion to make distributions of partnership income,
  2. The ability to make distributions in kind and
  3. The ability to amend the partnership agreement without the consent of the limited partners.

These powers caused the decedent’s partnership interest to be included in his estate. Turner has been positively cited by seven courts.

Strategy 9 – Basis adjustment planning

Tip: Congressional staffers advising federal tax committees have long understood the tremendous benefit for taxpayers of the so-called ‘step-up’ under IRC section 1014. Under current law, the basis of appreciated assets owned by the decedent is stepped-up to fair market value at death, eliminating built-in gains. Even taxpayers who don’t have taxable estates receive this benefit. With higher exemption amounts, planning to optimize the use of the step-up is more important than ever. For donors contemplating gifts this year, selecting which assets to gift is critical. Assets gifted away don’t get a stepped-up basis at death because they are no longer owned by the decedent. This includes assets that are sold to defective grantor trusts.

Trap: Traditional estate planning creates two trusts at the death of a married taxpayer. The so-called by-pass or credit shelter trust holds that amount that can be excluded from federal and state estate taxes at death and the other trust, the marital trust, which is typically the residuary trust. An exemption trust established at the first spouse’s passing prevents a second step-up of basis at the surviving spouse’s passing. Utilizing portability could allow for a second step-up in basis and should be examined in detail to assess the trade-offs.

Strategy 10 – Planning for estate taxes

Tip: The higher TCJA exemption thresholds will help many taxpayers avoid federal estate taxes. But given the uncertainty regarding future exemption amounts as well as the separate state estate tax regimes in seventeen states, many taxpayers, especially business owners and investors, must continue to plan for owing estate taxes at death.  Estate taxes are due nine months from date of death, and the best estate plans have considered payment strategies well in advance.

Two options allow for financing estate taxes.

1.    The first is a so-called Graegin loan arrangement. A Graegin loan provides an opportunity to use an outside lender instead of the IRS to fund the estate tax loan. The lender can be an external bank or a related party (family limited partnership or irrevocable gift trust) as long as the loan is bona fide. A Graegin loan has three requirements:

  • The estate must be illiquid,
  • The loan must be at a fixed rate and
  • The loan must prohibit prepayment.

Because the terms of the loan are fixed, the amount of the interest to be paid on the loan is ascertainable from the date of death, allowing the full amount of the interest to be paid to be permitted as a deduction rather than the discounted present value. This can create a sizeable favorable deduction for the estate. 

2.    Section 6166 provides a second option for financing estate taxes and allows for considerable deferral of estate taxes at a very reasonable interest rate. The section 6166 election is restricted to an estate with so-called ‘qualified business interests’. Essentially, the deceased taxpayer must have been an active business owner with a business interest that accounts for at least 35 percent of his or her adjusted gross estate. The election allows the deferral of the first payment of estate tax for five years and nine months from the decedent’s date of death. Thereafter, each successive payment is made annually for the next nine years until the debt has been paid off. This election is essentially a loan from the IRS at favorable low interest rates. Interest is payable annually. The deferral can be lost if the estate is delinquent in making its installment payments or the business is sold during the installment term.

Trap: Although the filing date for the estate tax return can be extended for an additional six months, the obligation to pay the estate taxes cannot be extended. If illiquidity is an issue for your estate, make sure that you have a financing plan in place. We recommend specifically authorizing your executor to enter into a Graegin loan arrangement and/or make a section 6166 election. The IRS has scrutinized related party Graegin loans.

Strategy 11 – Generation-skipping transfer tax exemption allocations

Tip: While the increased gift and estate tax exemption allows for additional transfers to the second generation, the increase in the generation-skipping transfer tax exemption (GSTT) allows for additional gifting to more distant generations. An automatic GSTT exemption allocation typically occurs when a transfer is made either as a direct skip to a person more than one generation younger than the donor or as an indirect skip to a trust in which there is a potential beneficiary that is more than one generation younger than the donor. If GSTT exemption allocations are not made to these trusts with potential skip beneficiaries, there may be a taxable event upon the death of the last primary, non-skip beneficiary. To protect against a taxable termination event, a late allocation of GSTT exemption to trusts with potential skip beneficiaries may be desired.

Trap: Late allocations of GSTT exemption require the trust to be valued at the current fair market value, not historical value, so it may require significantly more GSTT exemption to cover assets than it would have when the original gifting occurred.  Late allocations are effective when the Form 709 is filed, so valuations of trust assets cannot occur any earlier than the first of the month in which the return is filed.  This can create some logistical issues when a trust owns assets that require formal valuation reports.

The decision to either affirmatively allocate or not allocate GSTT exemption should be made on a gift tax return rather than relying on automatic allocation rules due to the complexity of those rules.  Also, the decision to allocate or not to allocate should be discussed with the client’s attorney and the client to determine the intent.  For example, a trust may be drafted as a dynasty trust but the intent is for the children to spend all of the trust assets.  In this case, affirmatively electing out of GSTT exemption allocation might be the intent despite the fact the trust was drafted as a dynasty trust.


Your tax advisors can provide further insight on these strategies and assist you in developing a unique estate plan tailored to your assets and your goals. If your estate is close to, or exceeds, the taxable threshold, you should meet regularly with your tax advisor to ensure that your planning is updated and that your documents are current.




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