Tax reform has been law for over two months now, and even though we still lack IRS guidance on many of the big questions arising from the act, planners are already exploring the ways they can assist their high net worth (HNW) clients in taking advantage of the changes (or mitigating the damage resulting from lost benefits). Bloomberg Tax recently hosted a webinar on the impact of tax reform on HNW individuals, providing a first glimpse into the possibilities, perils and pitfalls presented by the legislation. So, what exactly do we know at this still early point?

Perhaps the first and most obvious change relating to HNW individuals is the doubling of the estate and gift tax basic exclusion amount. At the time of writing, the IRS has not released an official inflation-adjusted number, but Bloomberg Tax projects it will be $11.18 million per taxpayer. The increase is scheduled to sunset after 2025 (returning to $5 million, adjusted for inflation), but could disappear even if there is a change in partisan control in Washington in 2021 (recall that Hillary Clinton proposed reducing the exclusion to $3.5 million and increasing the tax rate). So, planners should be looking to act; the question is how.

At this stage the changes appear to break clients down into a few groups. First, the “super HNW” clients. These individuals have estates well over the exclusions and have the ability to part with a sizeable chunk of wealth to take advantage of the full increase. For these clients the best advice appears to be to act now to make outright gifts up to the limit (and to do so in any years when cost of living further increases the amount).

The second group are clients with large, but not overly large estates. These clients may still be in a position to have some transfer tax impact, but do not feel comfortable enough to make an outright gift of $11 million. Planners will have to be more creative with their advice for these clients. One option for utilizing the exclusion increase while managing financial anxiety may be the use of spousal lifetime access trusts. If properly structured such trusts can soak up exemption while preserving access to trust assets. For single clients, variations of a domestic asset protection trust with distribution or beneficiary amendment power in a non-fiduciary may serve a similar function.

Finally, there are those who are not likely to be able to utilize the increase, even if they have estates over the former $5 million exclusion. For this group, planning likely continues as if the increase never happened at all – annual exclusion gifts and other traditional mechanisms for shifting assets will be the primary tools used. However, even these clients should review their documents, particularly if they employed formula clauses that may no longer be appropriate in achieving their goals.

A second significant change is the new deduction for qualified business income (QBI) under §199A. Taxpayers (including trusts and estates) with taxable income less than $157,500 ($315,000 for joint filers) may deduct 20% of QBI. For those over the threshold the deduction is subject to several limitations. First, for those in specified service businesses (law, medicine, investment management, etc.), the deduction phases out, zeroing out at $207,500 of taxable income ($415,000 for joint filers). In addition, those over the threshold will be limited to 50% of the W-2 wages paid by the business (or an alternate limit that accounts for depreciable property in addition to wages).

From a planning standpoint, the strategy for maximizing the advantages of the new deduction would appear to be “divide and conquer” – making efforts to break apart businesses and settling them in various trusts to bring the taxable income of each trust under the income thresholds (thereby avoiding, particularly, the service business limitation). Alternatively, some businesses may be able to segregate certain activities from a service business to minimize the impact of the limitations. For example, an optometrist may look to moving the business of eyeglass and contact sales into a separate entity from the service business of providing eye exams. Of course, to the extent a client plans on utilizing multiple trusts to accomplish their goal, care should be taken when drafting trust terms to avoid running afoul of the multiple trust rule under §643(f).

To close, a few other provisions are likely to be of interest to HNW individuals:
• The carried interest provision under new §1061 should be watched. The section is not a model of clarity in terms of its operation, meaning clients and planners should watch what guidance may be provided before creating appropriate structures.
• The limitation of tax-deferred like-kind exchanges under §1031 to real property may have an impact on clients that have historically used that provision to upgrade luxury items like private aircraft and yachts, as well as collectors take advantage of the ability to modify their art collections.
• Limits on the deductibility of state and local taxes, coupled with modifications to the AMT may cause some clients to actually see an increase in their marginal rates as they drop out of AMT without a noticeable increase in available deductions.
• Business interest deduction limitations could cause clients with significant business leverage to experience compound effects in down years where lower income triggers limits that do not comport with economic realities.

Much remains to be seen as Treasury and the IRS work to implement both new and changed provisions, but we will certainly continue to see new and creative planning ideals developing for some time to come. The apocryphal Chinese curse may indeed be reality: We are living in interesting times.

Dominick Schirripa is managing editor of estates, gifts and trusts at Bloomberg Tax.
 

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