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Editorial 7 MIN READ

Estate planning under the 2017 federal exemption

$5.49 million per person, $10.98 million per couple, and a state map that keeps changing

The Editors
Staff, Incorporator.org
7 min read Updated
Contents 6 sections
  1. The federal spine
  2. Portability, and the election people forget
  3. The state map, which is where the action is
  4. Where entity formation does work
  5. What the $5.49 million number actually implies
  6. Sources

he federal estate tax exemption for a death in 2017 is $5,490,000 per individual. A married couple who uses both exemptions properly shields $10,980,000. Above that, the marginal rate is 40%. These three numbers do most of the work of federal estate planning in April 2017; the rest is state-level variance and the choice of vehicle.

The $5.49 million figure comes from the IRS's annual inflation adjustment, published in Rev. Proc. 2016-55 last October. It is up from $5.45 million in 2016. The underlying statute, IRC § 2010(c), sets a $5 million base indexed to chained CPI since 2011, which is why the figure drifts upward a few tens of thousands of dollars each year.

The federal spine

A decedent's taxable estate is what remains after the marital deduction, the charitable deduction, debts, and administration expenses. The applicable exclusion — $5.49 million in 2017 — is applied against the tentative tax computed under IRC § 2001(c), whose top bracket is 40% on amounts above $1,000,000 (which is why, past the exemption, the marginal rate is flat 40%). The gift tax shares the same unified credit: lifetime taxable gifts reduce the exemption available at death.

The annual gift-tax exclusion for 2017 is $14,000 per donee, unchanged from 2016 (Rev. Proc. 2016-55). Gifts within the annual exclusion do not consume the $5.49 million exemption and do not require a Form 709. Direct tuition and medical payments under § 2503(e) are also outside the exemption entirely.

The generation-skipping transfer (GST) exemption tracks the estate exemption and is also $5.49 million in 2017. It is not portable between spouses, which is the first place DIY planning tends to break.

Portability, and the election people forget

Since the 2010 Tax Relief Act and the permanent fix in the American Taxpayer Relief Act of 2012, a surviving spouse can use the deceased spouse's unused exemption (DSUE) — the "portability" election under IRC § 2010(c)(5). The mechanics: the executor files a Form 706 for the first spouse's estate, even if no tax is due, and checks the box electing portability. The DSUE then stacks onto the survivor's own exemption.

Portability is the single most valuable administrative act in most moderate-wealth estates, and it is also the one that gets missed. A widow whose husband died in 2016 with a $2 million estate and no 706 filed has, as of 2017, lost roughly $3.45 million of DSUE she could otherwise carry. Rev. Proc. 2017-34, issued in June 2017, will give relief for estates below the filing threshold by extending the deadline to the second anniversary of death for a simplified late election, but in April 2017 the safer assumption is nine months from the date of death, extensible under § 6081 to fifteen.

Portability does not cover GST. It does not help with growth after the first death — the DSUE is a fixed dollar figure, not a share of a trust. And it does not exist in any state-level estate tax. A couple relying on portability for the federal exemption often still needs credit-shelter trust structure to handle the state layer.

The state map, which is where the action is

In April 2017, fifteen jurisdictions impose an estate tax, an inheritance tax, or both. The thresholds are well below the federal $5.49 million and, in several states, have not moved in a decade.

Oregon's estate tax starts at $1,000,000, with rates from 10% to 16% (ORS 118.010). Massachusetts and Washington, DC, each sit at $1,000,000 as well. Washington State starts at $2,129,000 for 2017 (indexed; RCW 83.100.020). Minnesota's 2017 threshold is $1,800,000, legislated to climb to $2 million in 2018 and $3 million by 2020 (Minn. Stat. § 291.016). Illinois holds at $4,000,000 (35 ILCS 405). Maryland, New Jersey, and Rhode Island each fall under $2 million.

New York is in year three of a five-year phase-in to match the federal exemption; its 2017 basic exclusion is $5,250,000 (N.Y. Tax Law § 952). Connecticut's exemption is $2,000,000 but, uniquely, the state also imposes a gift tax — meaning lifetime transfers out of the state estate are limited in a way they are not federally.

New Jersey is in the middle of repealing its estate tax. The 2017 threshold is $2,000,000, up from $675,000 in 2016; the tax is scheduled to repeal entirely on January 1, 2018 under P.L. 2016, c. 57. The inheritance tax remains.

For most clients with meaningful real property in these states, the binding constraint is not federal. A Portland resident with a $3 million estate owes nothing to the IRS and roughly $190,000 to Oregon.

Where entity formation does work

Formation is a tool, not a plan. Three structures come up often enough to be worth the mechanical overview.

The family LLC. A parent forms an LLC, contributes income-producing property or a portfolio, and gifts non-voting membership interests to children or to trusts for their benefit. The gift is valued with a marketability-and-minority discount — typically 15% to 35%, depending on the asset mix and the operating agreement's restrictions. Section 2704, which Treasury proposed to tighten in August 2016, is still in proposed form as of April 2017; the comment period closed in November and the final regulation has not issued. For now the discount is available on substantially the pre-2016 basis, though the aggressive end of the range is getting harder to defend. The formation state matters less than the operating agreement — transfer restrictions, buy-sell terms, and the absence of mandatory distributions are what support the discount.

The GRAT (grantor retained annuity trust) under IRC § 2702 and Treas. Reg. § 25.2702-3. The grantor transfers an asset to an irrevocable trust, retains an annuity for a term, and passes the remainder to heirs. If the asset outgrows the § 7520 rate — 2.6% for April 2017 per Rev. Rul. 2017-9 — the excess is out of the estate at zero gift-tax cost. Short-term rolling GRATs are the structure's dominant variant because they isolate underperformance to a single tranche.

The IDGT (intentionally defective grantor trust). The trust is treated as a grantor trust for income tax — so the grantor pays the tax on trust income, which is an additional tax-free transfer to the beneficiaries — but is outside the grantor's estate for transfer-tax purposes. Usually paired with an installment sale to the trust at the applicable federal rate (2.06% mid-term for April 2017; Rev. Rul. 2017-9) to freeze the asset's value.

Each of these requires entity formation, trust drafting, and a defensible valuation at the transfer date. None of them is self-service.

What the $5.49 million number actually implies

For the roughly 2 out of every 1,000 U.S. estates that exceed $5.49 million, federal estate planning is live. For the rest, the live questions are state estate tax in the fifteen jurisdictions that levy one, the portability election for surviving spouses, and step-up in basis under IRC § 1014, which quietly remains the largest tax benefit available to most heirs.

The planning error that does the most damage in April 2017 is not the absence of a GRAT. It is the portability 706 that a family, looking at a modest estate, decides not to file. By the time the surviving spouse dies a decade later with appreciated assets, the lost DSUE is the largest single number in the engagement letter.

Sources

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