Federal Gift, Estate and GST Tax

The new tax bill passed by Congress is expected to be signed into law by President Trump in the next few days.  Based on the changes that will take place as of January 1, 2018, there are several items that taxpayers should consider implementing prior to December 31, 2017.

Please note that each taxpayer’s situation is different and each suggestion below should be discussed with the taxpayer’s tax and financial advisors to determine what steps, if any, should be implemented now or deferred until next year or whether it should be implemented at all depending on the taxpayer’s business and tax attributes.

Items to consider:

  • Prepay real estate property taxes if you have amounts due for 2018 (cannot prepay NJ or NY state income taxes)
  • Prepay home equity interest (no deduction after this year)
  • Make charitable contributions this year, especially if not itemizing deductions in 2018
  • Accelerate business deductions
  • Medical expense deduction floor reduction to 7.5% only lasts through 12/31/18, so incur medical expenses if possible before then
  • Delay or accelerate Roth conversion
  • Defer or accelerate income*
  • If you are a US person with foreign businesses, potentially converting to an S corporation before year end could be beneficial due to a “deemed repatriation” of profits in the new bill
  • If you have children in private elementary, junior high or high schools and have not already been funding 529 plans, consider use of 2017 annual exclusions not otherwise exhausted to fund 529 plans

 

*Deferral of income until 2018 could save taxes for some taxpayers because of the lower marginal rates, while acceleration of income could save taxes for others due to the limitation on deductions of state and local taxes.  Whether or not a taxpayer is subject to AMT also plays a role.  Again, each taxpayer should consult his or her own tax and financial advisors for specific advice.

The IRS has withdrawn the controversial proposed regulations under Code §2704 that would have significantly affected the use of discounts in US estate planning.

Code §2704 provides that certain “applicable restrictions” on ownership interests in family entities – that is, entities where the transferor and family members control the entity – should be disregarded for valuation purposes.  The proposed regulations created new rules relating to a lapse of a liquidation right.  They also created a class of restrictions known as “Disregarded Restrictions” that included many common types of restrictions in business entities and would be ignored for gift and estate tax valuation purposes.  See our prior blog post on this topic.

The effect of the proposed regulations appeared to be that they would eliminate or greatly restrict minority interest and lack of marketability discounts that are commonly applied in gift and estate tax valuations (resulting in higher valuations).  The regulations were very controversial from the moment they were issued.  Among other things, commentators said the regulations were unclear and unrealistic.

Treasury and the IRS have stated that they now believe that the approach of the proposed regulations to valuation discounts is unworkable.  The IRS issued a notice (Notice 2017-38) that it was reviewing the proposed regulations as unduly complex or overly burdensome, and has now withdrawn the proposed regulations.

Experts have started to calculate the inflation adjustments to key estate and gift exemption amounts for 2018.  Note that these are not the official figures to be released by the IRS, but should be used as a guide.  The IRS will officially release the numbers later this year.

For an estate of any decedent dying during calendar year 2017, the applicable exclusion was increased from $5.45 million to $5.49 million.  This change increased not only the applicable exclusion amount available at death, but also a taxpayer’s lifetime gift applicable exclusion amount and generation skipping transfer exclusion amount.  This means a husband and wife with proper planning could transfer $10.98 million estate, gift and GST tax free to their children and grandchildren in 2017.  The projected 2018 adjustment to the applicable exclusion will increase from $5.49 million to $5.6 million which means that a husband and wife with proper planning could potentially transfer $11.2 million estate, gift and GST tax free to their children and grandchildren in 2018.

For 2017, the estate, gift and GST tax rate remains the same at 40% and the gift tax annual exclusion remains at $14,000.  For gifts made in 2018, the projected gift tax annual exclusion will be adjusted to $15,000 (up from $14,000 for gifts made in 2017).

The New Jersey Estate Tax repeal will be effective as of January 1, 2018.  The current $2 million exemption which increased on January 1, 2017 is set to be eliminated as of January 1, 2018.  Keep in mind that the New Jersey Inheritance Tax is still in effect. This is a tax imposed on transfers to beneficiaries who are not spouses, parents, children or grandchildren (i.e., nieces, nephews, siblings, friends, etc.) New Jersey Inheritance Tax rates start at 11% and go as high as 16%.

The New York exclusion amount was changed as of April 1, 2014.  Beginning April 1, 2014, the exclusion has increased as follows:

•           $2.0625 million for decedents dying between April 1, 2014 through March 31, 2015;

•           $3.125 million for decedents dying between April 1, 2015 through March 31, 2016;

•           $4.1875 million for decedents dying between April 1, 2016 through March 31, 2017;

•           $5.25 million for decedents dying between April 1, 2017 through December 31, 2018.  Beginning in 2019, the exclusion would be indexed for inflation, and equal to the Federal exclusion.

In 2017, the gift tax annual exclusion to a non-citizen spouse was increased from $148,000 to $149,000.  This is projected to increase to $152,000 in 2018.  While gifts between spouses are unlimited if the donee spouse is a United States citizen, there are restrictions when the donee spouse is not a United States citizen.

On June 9, 2017, the Internal Revenue Service issued Revenue Procedure 2017-34, which is effective immediately and provides a simplified method to obtain permission for an extension of time under Reg. 301.9100-3 to file Form 706 (Federal Estate Tax Return) and elect portability without the need to apply for a private letter ruling and pay the associated user fee.

Revenue Procedure 2017-34 applies to estates that are not normally required to file an estate tax return because the value of the gross estate and adjusted taxable gifts is under the filing threshold.

Portability of the estate tax exemption means that if one spouse dies and does not make full use of his or her $5,490,000 (in 2017) federal estate tax exemption, then the surviving spouse can make an election to utilize the unused exemption (deceased spousal unused exclusion (DSUE)), add it to the surviving spouse’s own exemption.  The DSUE is also available for application to the surviving spouse’s subsequent gifts during life.

In February 2014, the IRS issued Revenue Procedure 2014-18 that provided a simplified method for obtaining an extension of time under the “9100 relief” provisions to make a portability election that was available to estates of decedents dying after 2010, if the estate was not required to file an estate tax return and if the decedent was survived by a spouse.  This simplified method was available only on or before December 31, 2014.

After 2014, the IRS issued “numerous letter rulings” granting an extension of time to elect portability under §2010(c)(5)(A) when the decedent’s estate was not required to file an estate tax return.

The IRS acknowledged in Revenue Procedure 2017-34 that it has determined that the “considerable number of ruling requests” for an extension of time to elect portability “indicates a need for continuing relief for the estates of decedents having no filing requirement.”   Accordingly, Revenue Procedure 2017-34 allows for use of a simplified method to obtain an extension of time under the 9100 relief provisions to elect portability (provided that certain requirements are satisfied).

The IRS has made this simplified method available for all eligible estates through January 2, 2018, or the second anniversary of the decedent’s date of death.  The simplified method provided in Revenue Procedure 2017-34 is to be used in lieu of the letter ruling process.  No user fee is required for submissions filed under this revenue procedure.

The IRS has at last issued long-anticipated proposed regulations under Code §2704.  We perceive the proposed regulations as an attempt by the IRS to curtail the use of discounts – such as minority interest and lack of marketability discounts – in valuing transfers of interests in family-controlled entities for gift and estate tax purposes.

“Family limited partnerships” – that is, family investment entities usually structured as LLCs or limited partnerships – have been a popular estate planning technique for years.  Generally speaking, a client can transfer non-voting, non-marketable interests in these types of entities to children or a trust, and claim a valuation discount due to the restrictions that apply to the interest transferred.

Code §2704 provides that certain “applicable restrictions” on ownership interests in family entities, ie, entities where the transferor and family members control the entity, should be disregarded for valuation purposes.  The statute also permits the IRS to issue regulations providing for other restrictions (as determined by the IRS) to be disregarded in determining the value of a transfer to a family member, if a restriction has the effect of reducing the value of the transferred interest but does not ultimately reduce the value of such interest to the transferee.

The proposed regulations make two overarching changes.  First, changes under Code §2704(a) create new rules relating to a lapse of a liquidating right.  These changes are less relevant, at least in our practice, as we generally do not structure entities to include liquidation or other rights that lapse.

Second, changes under Code §2704(b) create a new concept of “Disregarded Restrictions.”  Under the proposed regulations, a restriction that will lapse at any time after the transfer, or a restriction that may be removed or overridden by the transferor (or the transferor and family members acting together) will be disregarded for gift and estate tax valuation purposes.  This is the case even if the restriction on the interest is pursuant to state law rather than a governing business agreement.  There are certain exceptions – for example, an owner’s right to liquidate or “put” his or her interest to the entity and receive cash within six months is not considered a “disregarded restriction.”

The effect of this rule appears to be that it would eliminate minority interest discounts, because the holder of any interest would be deemed to be able to liquidate his or her interest in the entity without restrictions.  The effect of the proposed regulations on lack of marketability discounts is unclear, although it seems the IRS similarly could argue for a small or zero lack of marketability discount on the theory that the holder of the interest is deemed to be able to liquidate the interest.

Thus, if the proposed regulations are adopted in their current form, they likely will increase the value for gift and estate tax purposes of transfers of interests in family-controlled entities.

The proposed regulations are controversial.  Commentators already have questioned whether the Treasury has exceeded its statutory authority in issuing the proposed regulations.  The proposed regulations are (at least in this author’s opinion) complicated and ambiguous, and perhaps unfair.  For example, if a client creates an LLC to purchase and manage a commercial property, and the client transfers an interest in the LLC to his or her child, and the interest is subject to typical restrictions on sale of the interest or the ability of a member to liquidate (largely because the asset owned by the LLC is illiquid and perhaps leveraged), then it seems that the true value of the interest transferred to the child would be reduced due to these restrictions (think about what a willing buyer would really pay the child for the LLC interest); however, under the proposed regulations, the value of the LLC interest transferred would be artificially inflated for gift tax purposes.

The proposed regulations are not effective until they are finalized.  Treasury has requested written comments by November 2, 2016 and a public hearing on the regulations is scheduled for December 1, 2016.