Traditionally, estate planning to maximize what passes to the next generation after taxes meant planning to reduce the federal estate tax. This was accomplished by reducing the size of a person's estate at death through a variety of planning techniques. However, an estate is subject to estate tax only to the extent the estate exceeds the estate tax exemption. Over the years Congress has been increasing the estate tax exemption. For the years 2011 through 2017, the exemption was increased to $5 million adjusted for inflation, which equated to an exemption of approximately $5.5 million in 2017 after the inflation adjustment. The 2017 Tax Cuts and Jobs Act temporarily doubles the exemption for individuals dying in 2018 through 2025. In 2026 the exemption will revert to $5 million adjusted for inflation. As a result, in 2018 the exemption will be approximately $11 million after the inflation adjustment. In 2026, when the law reverts to the prior rules, the exemption will be $5 million adjusted for inflation, which will probably result in an exemption in excess of $6 million.

In the case of a married couple, each spouse has an exemption. Therefore, in 2018 when the exemption is $11 million, with proper planning a couple would not have an estate tax liability unless their combined estates exceed $22 million because each spouse would have an $11 million exemption. Even after the exemption reverts in 2026 to the prior law, a couple would probably not have an estate tax liability unless their combined estates are more than $12 million, since each spouse will have a $5 million exemption adjusted for inflation, which would likely give each of them an exemption in excess of $6 million, or a combined exemption of $12 million.

Although the estate tax exemption is a changing number, one thing is obvious. A vast majority of the population will not be subject to federal estate tax because their estates will be less than the exemption. In such cases the goal of saving estate tax will become irrelevant and instead the focus will be on saving income tax rather than estate tax.

The reason income tax planning is a factor in estate planning is because Congress has retained the stepped-up basis at death rule. The stepped-up basis rule provides that upon a person's death, the cost basis in the deceased's property for purposes of determining gain or loss upon sale of the property, becomes the fair market value of the property on the date of the decedent's death. However, if the person gifts the property prior to his death, the cost basis of the recipient of the gift is the cost basis of the donor of the gift, which carries over to the recipient. For example, if an individual purchases an asset for $1,000 and dies holding the asset when it is worth $50,000, his heirs can sell the asset for $50,000 without incurring a taxable gain. However, had the person gifted the property prior to his death, and the recipient of the gift then sold the asset for $50,000, the recipient of the gift would incur a taxable gain of $49,000 because he would have taken the property with the donor's cost basis of $1,000 and sold it for $50,000.

In the case of an estate that is not subject to estate tax, which is now a large majority of the estates, giving away appreciated property prior to death results in no estate tax savings because there is no estate tax due in any case, and creates taxable income for the heirs when they sell the property. In such cases the focus will be on planning in order to take advantage of the stepped-up basis at death. To the extent parents want to help their children by making gifts to them, there will be an emphasis on making gifts with high basis assets.

In larger estates the donor will want to use the temporarily doubled exemption during the years 2018 through 2025 before it drops back down to the pre-2018 level. Since the exemption can also be used to make gifts during lifetime, which reduces the exemption available at death to the extent used during life, the donor will want to make gifts, but with gifts there is a carry-over basis rather than a stepped-up basis.  In such cases there will be plans to make gifts, and also obtain a stepped-up basis. One example of such a plan might be to make a gift and give an elderly relative with a modest estate a general power of appointment over the gifted property, which will cause the property to be included in the elderly relative's estate at his or her death and stepped-up to the fair market value at the relative's death. This would allow the donor to use the temporarily increased exemption through a gift at a time that the increased exemption is still available, and at the same time obtain a stepped-up basis.

In the cases where an estate plan was implemented to reduce estate tax when the exemption was much lower (in 2002 the estate tax exemption was only $1 million), if the estate is no longer subject to estate tax due to the increased exemption, it may be necessary to reverse the estate plan for income tax purposes. For example, it has become quite common to reduce the value of property for estate tax purposes with family limited partnership. The value of a $1 million asset could be discounted by 30 percent to 40 percent for estate tax purposes if the asset in placed in a family limited partnership, due to valuation discounts. If under the law at the time of the decedent's death, his estate would not be subject to estate tax even without the valuation discount, it would be disadvantageous to value the $1 million asset at, for example, $700,000 with the valuation discount, because the cost basis for income tax purposes would be only $700,000. Therefore, there will be moves to undo such planning so that the asset in the above example could be valued at death at the full $1 million and the heirs would inherit the property with a $1 million stepped-up cost basis rather than at the $700,000 discounted cost basis.

With the increased exemption, it will become even more important to review and revise estate planning documents. For example, a will may provide that the testator gives to his children the portion of his estate that is not subject to estate tax through use of the estate tax exemption, and gives the rest of his estate to his surviving spouse. Since bequests to surviving spouses are not subject to estate tax, this would result in an estate that is not subject to estate tax on the death of the first spouse to die. Such bequests may have produced the desired result when the estate tax exemption was $1 million, but with an $11 million estate tax exemption the result may not comply with the testator's intent. If the estate were $11 million or less at the testator's death, such a plan would leave the entire estate to the children and nothing to the surviving spouse because the entire estate would be sheltered by the estate tax exemption. Such a plan would have to be revised.

These are just some of the issues created by the changes in the tax law. Every individual's case is unique, and should be reviewed with his or her attorney.

Eugene Pollingue is a partner with Saul Ewing Arnstein & Lehr in West Palm Beach office. He focuses on estate planning and asset protection for high net worth clients, probate and income tax planning for commercial transactions.