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Federal Estate Tax Planning and Outlook

Fact Checked by Jason Herring & Barry Brooksby
Licensed Agents & Life Insurance Experts.
Insurance and Estates, a strategic life insurance provider composed of life insurance professionals, is committed to integrity in our editorial standards and transparency in how we receive compensation from our insurance partners.

The federal estate tax, also known as the inheritance tax, or by opponents as the death tax, has recently been dramatically altered by the Republican tax overhaul known as the 2017 Tax Cuts and Jobs Act.

Estate Planning and the Federal Inheritance Tax 

Federal estate tax DEFINITION: a tax that is levied upon one’s estate upon their death.  The tax is based upon the gross value of the estate after applying a “credit” without regard to indebtedness and the top rate as of 2016 rates is 40%.  The credit is also referred to as the “unified credit” and this amount has changed dramatically over the years due to the political uncertainties and schedules implemented in Washington.

For example, if the current credit is $11,200,000 for an unmarried person and the gross estate is $20,000,000, then $8,800,000 would be subject to taxation at a rate of 40%.  

Usually, estate representatives have 9 months from the date of death to pay the tax or work out an arrangement to do so.  The key question in defining this tax is whether it applies to your estate.  If you’re gross estate is less than the updated exemption amount of $11,200,000 then your estate wouldn’t be affected.  If you’re married, then the 2018 exemption doubles to $22,800,000 because the spouses’ exemptions are cumulative and may be transferred from one person to another or the last surviving spouse.

History of Death Tax Reform

The future of the federal estate tax (hereafter referred to as the “death tax”) has been a pending political question since George W. Bush took office in 2001.  At that time, President George W. Bush advocated for a repeal of the death tax and there was a Republican controlled Congress.

The death tax was actually repealed on a graduated scale with increasing credits (or exemptions) ultimately culminating a total repeal (or zero death tax) in 2010.  The repeal was not permanent and the death tax returned in 2011.  Since that time, the amount of gross estate assets exempted from taxation has remained somewhat in limbo but increased due to indexing for inflation.

There doesn’t appear to be much historical precedent for the death tax, although the IRS may claim otherwise and it is the subject of much debate for a few reasons as follows.

Proponents claim that this is a valid source of government funding and that it only impacts those in the top wealth bracket (top 2%)  in the United States.  Opponents of the death tax generally criticize it as a penalty on hard work and ingenuity. Moreover they claim that the death tax prevents families from passing wealth from one generation to the next.

Estate Planning Strategies and the Death Tax

When it comes to taxes, and especially the death tax, some of the biggest winners are actually the estate planners. Estate planning attorneys AND advance market insurance agents are kept very busy for good reason in implementing strategies to address the looming impact of the death tax upon families, family businesses, and small business partnerships.

Spousal Planning 

One way the death tax has stayed relatively consistent is allowing estate tax advantages for married couples.  This is therefore a common approach that families have adopted to limit the death tax historically.

How spousal death tax planning usually works.

As stated above, a single person can pass $11,200,000 free of death taxation.  So individually, a married couple could pass over $22 million free of federal estate taxation.  However, the marital exemption is better than that because one spouse can essentially pass his or her exemption to the other.

A-B Trust

It used to be…that the only way for one spouse to use the other spouse’s exemption was to put the deceased spouse’s share of the estate (or the amount exceeding the surviving spouse’s exemption) into a separate trust.  This common strategy was called an A-B trust (or credit shelter trust) and allowed the surviving spouse to use the assets in the protected trust (for health, education, maintenance and support) and upon the surviving spouse’s passing, the trusts assets and the surviving spouse’s assets could pass free of estate taxes.

A concept called “portability” was introduced in 2010 with the passage of the Tax Relief, Unemployment Reauthorization, and Job Creation Act of 2010 (“TRA 2010“) .  This new rule, which became permanent in 2012, allows a married person to use a deceased spouse’s exemption much more freely.

An A-B trust is therefore no longer necessary to take full advantage of both spouse’s full estate tax exemption amounts, although as we’ve discussed, there may be many other estate planning advantages to utilizing a revocable living trust.

A-B trusts or QTIP trusts may also be beneficial to one spouse who holds more wealth than the other and desires to control how the surviving spouse uses the estate assets.

Business Planning 

Family businesses (even those with substantial wealth) are sometimes forced to liquidate in order to pay the 40% death tax. This is a critical concern when considering strategies for family business succession planning.

The liquidity problem is especially relevant for asset heavy small businesses like farms or car dealerships that may have substantial asset value but lack the liquidity needed to pay the death tax AND continue to fund operations.

Small businesses need to find a way to assure liquidity as part of a business continuity succession plan in order to offset the demands of the death tax.

Creating liquidity through life insurance strategies such as implementing a buy-sell agreement OR purchasing key person life insurance is one way that small businesses can plan for the reality of the looming death tax.

Charitable Planning 

Another way is utilizing various exemptions and strategies such as gifting or devising a portion of the estate to charitable trusts.

The most common ways that charitable trusts are used for estate tax planning are through the charitable lead trust (“CLT”) or the charitable remainder trust (“CRT”).

With a CLT, the estate asset is transferred either during the lifetime of the principal owner or upon death to an irrevocable trust set up to pay income to a legitimate charitable organization.  The payment to charity must comply with IRS rules and is generally based upon a formula to pay the charity at a certain rate of return.  Generally, any overage of income can go back to the principal of the trust.  At the end of the payment period, the asset can then pass to the estate beneficiaries free of estate taxes.

With a CRT, the process happens somewhat in reverse.   The estate asset still transferred to an irrevocable trust at which time the estate receives a charitable income tax deduction.  The trust can then sell the asset at market value, with no capital gains tax, and reinvest the proceeds in income producing assets.  The trust can then pay the income to the principal owner, who will receive more than he/she otherwise would have due to the capital gains savings.  Upon the owner’s death, the asset would then pass to the designated charity free of federal estate taxes.

Planning for the Death Tax following the 2017 Tax Cuts and Jobs Act

The first step to planning for the death tax in 2018 is to see if your estate is affected under the current laws.  As mentioned above, the current exemption amount per person is $11,200,000 and portability allows $22,400,000 per couple to be exempted.

If you’re estate doesn’t reach this level of wealth after calculating the gross estate regardless of indebtedness, your need to plan for the inheritance tax is limited.  However, if you’re young and your estate is positioned for growth, or if you’re close to the line, some planning may still be required to manage the growth of your estate.

For example…,

…”gifting” strategies may be implemented to manage the estate.  Gifts are structured based upon the individual circumstances of the estate.

Gifting can be in the form of either regular annual gifts to various beneficiaries (currently $14,000 per beneficiary is allowed by the IRS) or a lump sum payment to an revocable trust vs an irrevocable trust such as an irrevocable life insurance trust (“ILIT“) or a charitable trust as discussed above.

Other planning strategies such as a qualified person residence trust (“QPRT“) may be advisable because this strategy can remove the value of the home from the estate.  In high real estate markets such as California the QPRT is more commonly used than other markets because the value of the home can result in major estate tax ramifications.

Spousal planning is still relevant, even with portability, because issues arise, such as an inheritance by one spouse from a parent, that would make it wiser for the other spouse to hold more assets prior to death.

Charitable planning is also an ever present option where the projected gross value of the estate is to exceed the estate tax exemptions.

In Conclusion…

If we are predicting the future based upon recent history, then the future of the death tax laws is anything but clear.

It will be important to conduct regular audits with your estate planning team to be sure that your plan is on track with current and future changes in the law not yet written.


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