From comprehensive tax reform making its way through congress, to the changes to the Minnesota estate tax, it has been an eventful year for estate planning. While tax changes are not the most exciting topic for many of our clients, it is a topic that continues to be important to their families and businesses.
As many clients know, the federal estate tax impacts very few estates. It is estimated that only .2 percent of all estates are taxable at the federal level. However, Minnesota, and almost 20 other states, continue to have their own state level tax on estates. Even if the federal estate tax is eliminated altogether, estate tax planning will continue to be relevant as long as states are imposing these taxes.
This article provides a quick review of some of the most important changes of 2017.
Updated 2018 Exemption Amounts: New Inflation Adjustments Take Effect for 2018
Each year, important estate tax numbers are adjusted for inflation. These adjustments impact gifts, estate tax and the generation-skipping transfer tax, which is a tax on transferring money over more than one generation.
The following chart compares the 2017 and 2018 levels:
| 2017 | 2018 | |
| Estate Tax Lifetime Exemption |
$5,490,000 | $5,600,000 |
| Gift Tax Annual Exclusion |
$14,000 | $15,000 |
| Gift Tax Exclusion, Non-Citizen Spouse |
$149,000 | $152,000 |
As a quick review, the estate tax exemption is the amount of money that one person can pass during their lifetime without incurring estate tax. Based on these numbers, very few taxpayers end up paying estate tax. Current estimates show that between .2 and .3 percent of all taxpayers will owe federal estate tax upon their death (but contrast the discussion of the Minnesota estate tax below).
The annual exclusion amount is the value of money or property that a person may give to any other person during a tax year. So, a father could give his child $15,000 in 2018 without needing to file a gift tax return. Spouses can combine their exemption amounts to give up to $30,000 in 2018 to any one child. Further, those same amounts may be given to any number of recipients each year. So a couple can give $30,000 to any one child, or $30,000 each to as many children, grandchildren, friends, or strangers that they may choose to make a gift to. If the taxpayer gives more than the annual exclusion amount to any person, then that gift must be reported on a gift tax return. The amount over the annual exclusion will reduce the taxpayer’s lifetime exemption amount, but no tax will be due until the lifetime exemption amount has been exhausted.
The gift tax exclusion for non-citizen spouses is the amount that one spouse may gift to the other, if the receiving spouse is a non-citizen. It may seem like a lot, especially given that it is roughly ten times the normal gift tax exclusion. However, compare the non-citizen exclusion to the normal exclusion for citizen spouses, where one spouse may transfer an unlimited amount to the other spouse.
Updated 2018 Minnesota Estate Tax Exemption: New Inflation Adjustments Take Effect for 2018
The past year has been an eventful year for the Minnesota estate tax. As part of the Minnesota tax bill, the legislature passed a significant increase in the Minnesota estate tax exemption. That bill was signed by Governor Mark Dayton, who also used the opportunity to exercise his line-item veto.
Governor Dayton objected to four items in the bill, including the increase in the estate tax exemption. However, rather than using the line-item veto on the exemption, the veto was used to veto funding for the Minnesota legislature. By doing this, Governor Dayton hoped to gain leverage to remove other provisions, including the increase in the estate tax exemption.
The legislature has sued, claiming that the use of the line-item veto was unlawful because it interferes with the separation of powers. The suit is currently pending before the Minnesota Supreme Court.
Prior to the tax law passed in May, the exemption had been increasing by $200,000 per year, as follows:
| 2013 | $1,000,000 |
| 2014 | $1,200,000 |
| 2015 | $1,400,000 |
| 2016 | $1,600,000 |
| 2017 | $1,800,000 |
| 2018 and after | $2,000,000 |
While our office is monitoring the status of the suit, we are also working with the current status of the law. Beginning in January of 2017, the Minnesota estate tax exemption has changed to the following:
| 2017 | $2,100,000 |
| 2018 | $2,400,000 |
| 2019 | $2,700,000 |
| 2020 and after | $3,000,000 |
Along with the difficulty that Governor Dayton faces in the legal challenge of his veto, there are also significant practical difficulties that could prevent him from changing the increased exemption. First, with every month that passes, more personal representatives have filed estate tax returns relying on the current, increased, exemption amount. Second, trustees have relied on these numbers to calculate the amount funded to bypass trusts following the death of the grantor. Any change to the law at this point would need to address the ever increasing number of estates that have relied on the current state of the law.
Federal Estate Tax Repeal: Proposed Estate Tax Repeal May Repeal or Raise the Estate Tax Exemption
The biggest tax topic of the year is the pending Republican tax bill. While the focus of the bill has been on corporate and individual income tax reform, the estate tax is also likely to change. Both the House of Representatives and the Senate have passed tax bills addressing the estate tax. The bills differ in significant ways, and are headed towards reconciliation.
Currently, the estate tax applies to estates of greater than $5,490,000 and double that amount for couples who engage in estate planning. That amount is referred to as the lifetime exemption – the amount that any one person can gift during their lifetime, or leave to others after their death. Estates in excess of the lifetime exemption amount are taxed at the rate of 40%.
The Senate bill addresses the lifetime exemption amount on a temporary basis. It would raise the lifetime exemption from the current level to $10,000,000 per person. The increase would take effect on January 1, 2018, and be effective until December 31, 2025. During that period, the amount would be adjusted annually for inflation. If action has not been taken prior to January 1, 2026, the lifetime exemption would revert to pre-2018 levels.
The House bill would similarly increase the lifetime exemption as of January 1, 2018 to $10,000,000, and provide for inflation adjustments. However, as of January 1, 2024 the estate tax would be eliminated.
In addition, the House bill eliminates the generation-skipping transfer tax. It also provides for a reduced gift tax rate beginning on January 1, 2024, dropping the rate from 40% to 35%.
While it is too early to know the exact impact of the reconciliation process, it is unlikely that the reconciled bill will result in the repeal of the estate tax. That is because Senate rules relating to deficits will require major portions of the tax cut to be phased out. Look for the estate tax exemption provisions to phase out, putting us in a very similar position to what we saw under the Bush tax cuts of the early 2000s.
Family Limited Partnership Update: The Proposed Restrictions on Family Limited Partnerships Are Now Unlikely to Take Effect
Maybe the most interesting tax update of 2016 was the proposed valuation rules for family-owned businesses. In August of 2016, the IRS issued proposed regulations impacting Section 2704 of the Internal Revenue Code. This Section of the Code relates to the valuation of interests in limited partnerships. Under this section, families are able to discount the value of minority interests in family limited partnerships (“FLP”). The discount is based upon the lack of marketability, and lack of control over the company.
The proposed IRS regulations would have limited or eliminated the ability of families to use the FLP to receive discounts on gifts to family members. At the end of 2016, many tax planners believed the change for FLPs was inevitable.
However, in July of 2017, the IRS flagged the proposed regulations for review. This new scrutiny appears to be directly related to an executive order signed by President Trump in April of 2017, which requires the Treasury Secretary to reduce undue regulatory burdens. The Treasury will be seeking comments on whether the proposed regulations should be abandoned or changed.
At this point, the proposed regulations are not in effect. Further, it looks like the proposed regulations will either be modified significantly, or abandoned entirely. This is good news for small business owners, who should be able to continue using valuation discounts for the foreseeable future.