2019 Transfer Tax Updates

By: Randall A. Denha, J.D., LL.M.

President Trump signed the Tax Cuts and Jobs Act (the “Act”) on December 22, 2017, implementing a new law that affects many taxpayers. This Alert addresses some of the changes to the federal estate, gift, and generation-skipping transfer tax laws, as well as issues for consideration as individuals look to update their estate plans.  As you know, The Act doubled the federal estate, gift, and generation-skipping transfer tax exemptions through the end of 2025. As such, effective January 1, 2019, each individual has a federal exemption of $11,400,000, or $22,800,000 for a married couple. As of January 1, 2026, the estate tax laws are scheduled to revert to the pre-Act law (effectively slashing the exemptions in half). The value of a person’s estate that is in excess of his or her remaining applicable exemption will be subject to an estate tax at death at a flat rate of 40 percent.

What This Means for Your Current Will, Revocable Trust and Estate Plan

The estate and gift tax regimes have been permanent and unified since the passage of The Act. Further, individuals should reconsider the terms of their current estate plans to ensure the provisions in their documents are still applicable. Wills and revocable trusts often use formulas to calculate the amount to fund certain trusts upon a decedent’s death. Those formulas are often tied to the federal estate tax exemptions in effect at the time of a decedent’s death. Individuals should revisit their plans to review whether any formulas in their documents will have unintended consequences given the new estate tax exemptions. Certain plans could result in more assets passing to a spousal trust or to a generation-skipping transfer tax trust than originally anticipated. Other plans could be streamlined and simplified by the increased exemptions.

Tax Exemption Inflation Increases for 2019

For 2019 the increases under the 2017 Act are as follows:

• In 2019, there is a $11,400,000 federal estate tax exemption and a 40% top federal estate tax rate.
• In 2019, there is a $11,400,000 GST tax exemption and a 40% top federal GST tax rate.
• In 2019, the lifetime gift tax exemption is $11,400,000 and a 40% top federal gift tax rate.
• In 2019, the annual gift tax exclusion is $15,000.

Note that the increased exemption is scheduled to sunset on December 31, 2025. Under proposed regulations issued by the IRS and Treasury on November 20, 2018, it would be clarified that the government will not claw back amounts given away between 2018 and 2025 with respect to someone who dies in 2026 or beyond when the gift and estate tax exemptions are set to return to a $5 million exemption, indexed for inflation, which applied under 2012 Act. Treasury has just confirmed that the increased estate and gift tax exemption is a use it or lose it proposition. This is important not only for avoiding the 40% gift and estate tax, but also the 40% generation-skipping transfer tax exemption. In effect, this preserves the additional amount of exemption for children and several generations thereafter.

These increased exemptions under the 2017 Act create opportunities to make larger lifetime gifts, to leverage more assets through a variety of estate planning techniques (such as a sale to a grantor trust) and to shift income producing assets to individuals such as children or grandchildren who may be in lower income tax brackets and/or reside in states with a low income tax rate or no state income tax.

In particular, those who used substantially all of their exemptions prior to 2018 should now consider making additional lifetime gifts to utilize the increased exemptions before they sunset at the end of 2025.

How do these changes affect your existing estate planning documents?

Also, if gifts are made in excess of the annual exclusion, there is a lifetime exclusion that also applies.  As indicated above, the unified estate and gift tax lifetime exclusion amount is $11,400,000 for 2019.  This amount will be indexed for inflation till the year 2025 and is scheduled to go back to approximately $6,000,000 effective 1/1/2026.  For married couples, the rules of portability still apply.  Portability allows the surviving spouse to use the deceased spouse’s unused estate tax exclusion in addition to their lifetime gift and estate exclusion.

It is important to note though, that when the first spouse dies and their estate is below the lifetime exclusion and thus there would be no estate tax due, an estate tax return is required to be filed timely to in order to make the portability election.  This concept effectively gives a married couple the ability to pass on to their heirs free from federal estate taxes $22,800,000 from 2019 until 2025.

With this increase in the lifetime exclusion, it is still important to review your estate plan as the exclusion amount is scheduled to revert to a lower level and gifting now could “lock-In” the current exclusion thus permanently avoiding future transfer taxes.  Existing estate plans should be reviewed to ensure that the change in exclusion amount does not negate or disrupt your initial estate plan and use of trusts and remember to always draft for flexibility in your plan.

Gift Tax Planning

Take Advantage of the Gift Tax Annual Exclusion Amount

In 2019, the gift tax annual exclusion amount per donee will remain $15,000 for gifts made by an individual and $30,000 for gifts made by a married couple who agree to “split” their gifts.

If you have not already done so, now is the time to take advantage of your remaining 2018 gift tax exclusion amount, being $15,000 for gifts made by an individual and $30,000 for gifts made by a married couple who agree to “split” their gifts, so that you can ensure that gifts are “completed” before December 31, 2018.

In lieu of cash gifts, consider gifting securities or interests in privately held companies or other family-owned entities. The assets that you give away now may be worth significantly less than they once were, and their value hopefully will increase in the future. So the $30,000 gift that your spouse and you make in 2018 (and the $30,000 gifts that you and your spouse make in 2019) may have a built-in discount that the Internal Revenue Service cannot reasonably question. That discount will inure to the benefit of your beneficiaries if the value of those assets rises.

Your annual exclusion gifts may be made directly to your beneficiaries or to trusts that you establish for their benefit. It is important to note, however, that gifts to trusts will not qualify for the gift tax annual exclusion unless the beneficiaries have certain limited rights to the gifted assets (commonly known as “Crummey” withdrawal powers). If you have created a trust that contains beneficiary withdrawal powers, it is essential that your Trustees send Crummey letters to the beneficiaries whenever you (or anyone else) make a trust contribution.

If you have created an insurance trust, remember that any amounts contributed to the trust to pay insurance premiums are considered additional gifts to the trust. As a result, the Trustees should send Crummey letters to the beneficiaries to notify them of their withdrawal rights over these contributions. Without these letters, transfers to the trust will not qualify for the gift tax annual exclusion.

2018 Gift Tax Returns

Gift tax returns for gifts that you made in 2018 are due on April 15, 2019. You can extend the due date to October 15, 2019 on a timely filed request for an automatic extension of time to file your 2018 income tax return, which also extends the time to file your gift tax return. If you created a trust in 2018, you should direct your accountant to elect to have your GST tax exemption either allocated or not allocated, as the case may be, to contributions to that trust. It is critical that you not overlook that step, which must be taken even if your gifts do not exceed the annual gift tax exclusion and would, therefore, not otherwise require the filing of a gift tax return.

Make Sure that You Take Your IRA Required Minimum Distributions by December 31, 2018

If you are the owner of a traditional IRA, you must begin to receive required minimum distributions (“RMDs”) from your IRA and, subject to narrow exceptions, other retirement plans, by April 1 of the year after you turn 70 ½. You must receive those distributions by December 31 of each year. If you are the current beneficiary of an inherited IRA, you must take RMDs by December 31 of each year regardless of your age. The RMDs must be separately calculated for each retirement account that you own, and you, not the financial institution at which your account is held, are ultimately responsible for making the correct calculations. The penalty for not withdrawing your RMD by December 31 of each year is an additional 50% tax on the amount that should have been withdrawn. Please consult us if you need assistance with your RMDs.

Tax-free qualified charitable distribution directly from an IRA.

Taxpayers age 70 ½ and older must take required minimum distributions (RMD) from their IRA’s before the end of the year.  One way to reduce the tax burden of this distribution is to directly transfer the RMD to a qualified charity up to $100,000.  When this is done, the distribution is not included in income on page 1 of the Form 1040 and since the income is not included, there is not a charitable deduction for the transfer to the charity on Schedule A of Form 1040.  This tax free transfer was made permanent.

A few items to note is that the distribution must be make directly from the IRA to the charity and the charity must be a qualifying charity, this does not include a private foundation or a donor advised fund.  Also for a married couple, if both spouses have an IRA with a RMD requirement, both can do the qualified charitable distribution up to $100,000 each.

Crummey Notices – Some Suggested Practices

Quick Background of Law

Under current tax law, an individual is entitled to make gifts of up to $15,000 per donee per year without being subject to gift tax. This $15,000 is commonly referred to as the “annual exclusion amount” because it refers to the annual amount a donor can give to a person that is excluded from the donor’s taxable gifts. In general, gifts in trust are not eligible to be annual exclusion gifts—a transfer must be both outright and a gift of a “present” (as opposed to future) interest to be excluded from the donor’s total gifts.

However, contributions to certain irrevocable trusts can take advantage of the annual exclusion amount, if the trust has a provision that allows one or more trust beneficiaries to exercise withdrawal rights over a portion of the donor’s contributions (generally, each beneficiary will hold the right to withdraw up to $15,000 each year). A withdrawal right is considered the equivalent of receiving an outright gift of a “present interest,” because the beneficiary has an unrestricted right to the immediate use, possession or enjoyment of property he or she is entitled to withdraw. Accordingly, these provisions allow the donor make transfers to the trust while at the same time using his or her annual exclusion amount in respect of each beneficiary holding a withdrawal power over the contributions to that trust. These withdrawal rights, which are frequently contained in insurance trusts, are commonly called “Crummey” withdrawal rights, after the petitioner in Crummey v. Commissioner, a landmark case approving arrangements involving Crummey withdrawal rights.

Trust beneficiaries rarely exercise their withdrawal rights. However, donors and beneficiaries must never have an express or implied agreement that the withdrawal rights will never be exercised. The IRS views any advance agreement between donors and beneficiaries not to exercise withdrawal rights as though the withdrawal rights were illusory, and thus not gifts of present interests qualifying for the annual exclusion.

Typical “Crummey” Withdrawal Provisions

A trust agreement with a typical Crummey withdrawal right provides that, whenever property is contributed to the trust, one or more trust beneficiaries (or a guardian or other person on behalf of a minor or incapacitated beneficiary) has a right to withdraw a portion of such contribution for a certain period of time. The trust agreement usually provides that the trustee of the trust must give the beneficiary timely notice of each contribution and notify the beneficiary of the amount subject to his or her withdrawal right. The amount subject to withdrawal by each beneficiary is generally capped at the annual exclusion amount (now $15,000) reduced by any previous gifts to that beneficiary by the donor within the same calendar year. If the beneficiary does not notify the trustee of his or her election to exercise the withdrawal right, the right to withdraw usually lapses after a period of time or at the end of the calendar year.

Notice Requirement

In assessing whether a Crummey withdrawal right renders a transfer a gift of a present interest, all of the circumstances surrounding the making of a gift, (including the timing of notice and the length of the period the beneficiary can exercise the withdrawal right) are taken into account. One important factor in this analysis is notice to the beneficiaries of the contribution of withdrawable funds. This section discusses recommended practices for giving and creating records of such notice to the beneficiaries. While in some cases, there is the potential for valid Crummey powers even if notice is not given (see below regarding the case of Turner v. Commissioner), to ensure the meaningfulness of the withdrawal right (and thus the annual gift exclusion treatment), as a matter of best practices, the beneficiary should have a reasonable opportunity to exercise a Crummey right, generally meaning that the he or she should be (i) aware that the right exists and (ii) given enough time to exercise the right before it lapses.

For purposes of requirement (ii) above, a period of 30 days from the contribution of property until the expiration of the withdrawal right is sufficient. For purposes of requirement (i), authority is clear: so long as actual notice is provided to the beneficiary, requirement (i) is satisfied.

The trust agreement itself frequently includes guidance regarding the steps that the trustee must take whenever a withdrawable contribution is made. The precise manner, timing and contents of this notice (discussed in greater detail below) may or may not be specified in the trust agreement, but if the trustee provides notice to the beneficiaries in a manner that differs from what the agreement requires, the trustee will be in violation of the terms of the agreement (and potentially liable to the beneficiaries) even if the trustee has met the legal requirements regarding notice. Ideally, the trust agreement should include a nonexclusive list of several manners by which notification may be provided, such as written, verbal, or electronic notification, in order support a trustee’s assertion upon audit that notice was provided via a method sanctioned by the agreement.

Adequacy of Notice

From an evidentiary perspective, in the event of an audit, the optimal way for a trustee to notify a beneficiary of a withdrawable contribution is for the trustee to give the beneficiary written notice. A copy of the notice, signed by the trustee (together with a statement affirming that the notice was mailed to the beneficiary or guardian) is strong evidence that the beneficiary was made aware of his or her withdrawal rights. Alternatively, notice can be emailed by a trustee to a beneficiary, and the email can be printed as written evidence that notice was sent to the beneficiary. In addition, it is best (though not required) to have the beneficiary sign an acknowledgment that he or she actually received notice.

Written notice, however, is not required by Internal Revenue Code, the Treasury Regulations, Revenue Rulings or case law. Written notice is simply the best practice from an evidentiary standpoint, in the event of an audit. As a legal matter, however, verbal notice also meets the notice requirement.

In cases where the trustee is himself or herself a beneficiary holding a withdrawal right, or the trustee is the parent and natural guardian of a minor beneficiary holding a withdrawal right, the IRS has noted that the trustee has “actual notice” of the withdrawal rights by virtue of his or her status as trustee. As a result, the trustee need not provide any formal notice to himself or herself with respect to either his or her own withdrawal rights, or the withdrawal rights of his or her minor children, because actual notice suffices.

Contents of Notice

When a trustee provides notice of withdrawal rights to a beneficiary, the notice should include the following items: (i) a statement that a gift was made to the trust, (ii) the amount of the gift that is subject to the particular beneficiary’s right of withdrawal, (iii) the amount of time the beneficiary has to exercise the withdrawal right before it lapses, and (iv) a request that the beneficiary notify the trustee if he or she wishes to exercise the withdrawal right. Including these four items will ensure that the beneficiary is fully aware of the nature of his or her withdrawal right and informed of the manner in which it must be exercised.

The Importance of Annual and Other Periodic Payments in the Event of a Tax Audit

Many estate planning techniques require annual and other periodic payments to accomplish their desired results. For example, intra-family loans must include an interest component at or above the applicable federal rate, or aspects (including all) of the transaction could be treated as a taxable gift. Similarly, a grantor-retained annuity trust, or GRAT, will trigger a large taxable gift unless periodic (usually annual) annuity payments are made to the grantor of said trust.

The promissory note, trust agreement or other document governing such an arrangement must always contain language creating an obligation to make these payments. Equally important, however—and increasingly investigated by the IRS—is the actual payment of such obligations. For example, on audit, it is more and more common for the IRS to request evidence that loan interest was not only charged, but also paid. If the taxpayer cannot prove payment, the IRS may characterize the loan as a gift rather than a debt (or potentially, if made to a business, as equity in the business). This trend underscores the importance of timely paying all periodic obligations under common estate planning techniques.

Please be sure that, to the extent the below techniques are part of your estate plan, all annual payments thereunder are made documented:

Interest Payments. All interest payments under promissory notes must be made at the appointed time and compounded as required in the promissory note. If the note provides for late payment charges, those charges should be calculated and paid.

GRAT Annuity Payments. Annuity payments must be made each year (or if the trust instrument so provides, more often) pursuant to the terms of the trust agreement and applicable law.

Rent for Estate Planning Purposes. If you are living on real property that you have transferred into the legal ownership of an irrevocable trust, you may have a rental agreement with that trust. All rent must be timely paid, or you could risk the invalidation of the transfer or adverse tax consequences.

Charitable Lead Trusts. A charitable lead trust is a trust that makes periodic payments to a charity for a defined period, then terminates in favor of a family member or other non-charitable beneficiary. If you have a charitable lead trust in your estate plan, all required transfers must be paid periodically as required by the trust agreement.

Charitable Remainder Trusts. The inverse of a charitable lead trust, a charitable remainder trust is a trust that makes periodic payments to a non-charitable beneficiary (for example, a family member) for a defined period, then terminates in favor of a charity. If you have a charitable remainder trust in your estate plan, all required transfers must be paid periodically as required by the trust agreement.

Crummey Notices. If you have irrevocable trust contributions which receive the benefit of the annual gift tax exclusion, each contribution to the trust should be disclosed to any beneficiaries holding a withdrawal power over the contribution. These disclosures (or “Crummey notices”) should be made in writing, and, if possible, evidence of the beneficiary’s receipt (such as a signed acknowledgement) should be gathered and preserved.