While it's been over a year now since the Tax Cuts and Jobs Act (TCJA) was initially passed last year, understanding the many technical aspects of the act, and more specifically how these changes will impact one's estate planning remains a challenge for many individual and families.
As their trusted adviser, efficiently communicating how they can take advantage of the new tax environment, and the opportunity to undertake new approaches can be equally daunting. To help in these conversations, Martin Shenkman from The CPA Journal takes a closer look at four of the most frequent responses you could receive from clients arguing against updating an estate plan in the wake of the TJCA.
Our team stands ready to answer any questions you may have to help make these conversations with your clients more impactful.
This will be true for many individuals, but estate taxes never should have been the only, or even the most important, factor in anyone’s planning. Advisors should stress that, regardless of the size of the estate, everyone needs planning. The response to this objection should take several approaches, depending on the individual’s circumstances.
CPAs understand that estate planning should address an array of nontax issues. Aging individuals should address later life planning to protect themselves from elder financial abuse and other potential problems. This might include consolidating assets with a single wealth advisor, funding a revocable trust naming a trust protector for a check and balance on the trustee, and much more. Asset protection is a critical step for many individuals, not just the rich. Few people to take sufficient steps to protect their assets. Even fewer follow up regularly on the operation of the asset protection structures that they do create. Advisors need to reinforce the importance of nontax planning in a manner relevant to that individual.
One of the most common ways individuals deflect a conversation about the need to update their estate planning is to suggest that they updated their plan and documents only a few years ago. If a new medicine were developed, no one would ignore it because their doctor had prescribed a different medication a few years before. Taxpayers certainly can be annoyed by changes in the tax law, but they ignore those changes at their own peril.
The most common excuse for not addressing planning is “nothing has changed,” but with the TCJA, much has changed. If individuals have wills (or revocable trusts) that use formula clauses, those formulas could be disastrous under the new law if not updated.
There have indeed been many years over the last decade when clients have received newsletters, emails, or even calls from their advisors encouraging them to update documents and planning for changes in the law. For such individuals, the frustration is understandable, but the solution is obvious as well. Modern trust and estate planning can utilize several provisions to incorporate flexibility into the planning and documents, far more so than what conventional planning afforded only a few years ago. These tools are discussed below.
Revocable trusts can be used instead of wills to provide more flexibility, such as to move a trust formed on death to a better jurisdiction (i.e., friendlier legal and tax environment). Trusts might also include a trust protector empowered to make certain changes to the trust agreement, move the situs and governing law of the trust, and so forth.
Decanting (the process of merging an old trust into a newer trust with better or more modern administrative provisions) has become more common in recent years. But advisors should not depend upon state law alone to facilitate a decanting. New trusts can include these provisions as well. Encourage the client’s attorney to use robust trusts that include this and other modern trust provisions.
In the current planning environment, non-grantor trusts (which pay their own tax, and might provide some IRC section 199A, state and local tax, charity, and other benefits) are popular. If the individual tax changes enacted as part of the TCJA sunset after 2025, as the law provides, it may be more advantageous to convert nongrantor trusts back to a grantor trust. The powers that create grantor trust status might include provisions to renounce those powers so that conversion to a nongrantor trust is also feasible. A person could be named in the trust instrument—perhaps expressly designated not to act in a fiduciary capacity—who can exercise powers to turn on or off grantor trust status.
Powers of appointment (the right to designate to whom trust assets shall pass) are more frequently being included in instruments. Historically, these had been used primarily to avoid an unintentional GST tax; now, however, they are used to provide important flexibility to effectively rewrite trusts, given the tendency towards using long-term or even perpetual trusts. Powers can also be modified from limited powers into general powers of appointment, which can cause a step-up in basis on death.
There are many ways that a modern trust can be made more flexible to deal with continued uncertainty. The sooner individuals embrace modern trust and estate drafting, the sooner they can infuse their documents with this flexibility.
Financial planning, investment location decisions, and insurance planning have all been affected by the TCJA. No estate plan can be addressed optimally without addressing these matters as well.
Some individuals might cancel their life insurance policies, believing that those policies are no longer necessary to pay an estate tax they no longer expect to owe. Even if this was the primary reason for the purchase initially, it should not be the only factor to consider when evaluating a policy now. Might the policy be useful to pay an estate tax when the exemption is halved in 2026? What if the value of the estate compounds at a rate that subjects it to estate tax? Does the insurance provide a ballast to offset the risk of concentration of most of the estate in a closely held business?
Investment allocation and location decisions should be tailored to the individual’s circumstances and estate plan. In very simplistic terms, a financial advisor might concentrate tax-efficient assets, such as growth stocks, in personal accounts and tax-inefficient assets, such as bonds, in qualified plan accounts (where they will not generate current income tax). Post-TCJA, many clients will benefit from creating non-grantor trusts (like the one used for charitable planning illustrated above). Some portion of the income from these trusts may pay charitable donations and provide a dollar-for-dollar deduction, which the client might not realize individually because of the higher standard deduction. Some nongrantor trusts will be formed and administrated outside of the taxpayer’s high-tax home state, thus presenting trusts with a new and unique tax bucket for asset location decisions. Tailoring the investment location decisions to account for the tax profile of the trusts is another important nuance to better planning.
As individuals with moderate wealth seek to capitalize on the current high temporary gift, estate, and GST exemption amounts, they may transfer substantial portions of their wealth to irrevocable trusts. Having an appropriate insurance plan (e.g., life, long-term care) to backstop these transfers could be a new, important use of insurance planning for some clients.
Roth IRA conversions can provide valuable income tax benefits for many individuals. Since the TCJA has doubled the standard deduction, however, using regular IRA funds to make charitable contributions may be an ideal way to secure charitable contribution deductions for some individuals. This calculation adds a new wrinkle to the Roth conversion analysis.