As an update to our prior article New Law Doubles the Estate Tax Exclusion Amount but Only Through 2025, in March the IRS published the final 2018 lifetime exemption and GST exclusion amounts for 2018 of $11,180,000. We previously shared $11,200,000 as a preliminary figure.
In recent articles we have discussed the impact of the Tax Cut and Jobs Act of 2017. As with prior law, certain provisions of the tax code contain figures that the IRS adjusts annually for inflation. For estate planning purposes, some of those figures include the annual exclusion amount, the estate exemption amount and the Generation Skipping Tax (GST) exclusion amount. These figures will continue to be adjusted annually for inflation under the 2017 Tax Act, however, the inflation adjustments will now be based on chained CPI (consumer price index) rather than CPI.
What does this mean? Simplistically, CPI is the price of a fixed “basket of goods.” The amount that the price of that basket of goods increases or decreases in a particular timeframe is the inflation (or deflation) rate and is used by the IRS in determining cost of living adjustments (COLA). CPI is typically calculated on a single month-by-month basis. Chained CPI provides a more accurate estimate of changes in the cost of living from one month to the next by using market baskets for both months (recognizing substitutions when prices of goods changes), thus “chaining” the months together. This resulting difference in calculations is a few tenths of a percentage point but, over time, this adds up. In general, chained CPI will result in lower estimates of inflation over time and thus, lower COLA bumps for things like tax brackets, retirement plan contribution limits, standard deduction, and tax credits. To put this in perspective, between 2000 and 2015 the average chained-CPI was 1.89%, whereas the average CPI was 2.16%. The difference between the two rates is relatively small, but it does add up to higher taxes over time.
The 2017 Tax Act made the use of chained CPI permanent, but it was unclear for the first quarter of the year exactly how this impacted current exemptions, exclusions, and deductions. In March, the IRS clarified the inflation adjustments for 2018 under the 2017 Tax Act. We now know that some figures that we previously reported to you have been adjusted to be aligned with the chained CPI calculation. Importantly, the lifetime exemption and GST exclusion amounts are now known to be $11,180,000 per individual for 2018 (rather than the previously reported, $11,200,000).
Other provisions that are impacted by the chained CPI calculation include: the adoption credit, lifetime learning credit phase-out amounts, HSA annual limits, IRA deductible contribution limits, Roth IRA AGI based dollar amount limits, applicable exclusion amount, and lifetime exclusion amount.
Many of these provisions provide “rounding down” language so adjustments are not made to a particular amount until a limit has been reached. For example, the annual exclusion amount is adjusted for inflation annually but rounded down to the nearest $1,000 multiple so we don’t actually see changes to the limit every year until the cumulative increase is greater than $1,000. This means that chained CPI will not affect many of the provisions in 2018 and future increases will be pushed further out.
As a side note, the calculation of Social Security COLA was not impacted by this change and will continue to be tied to CPI-W (Consumer Price Index for Urban Wage Earners and Clerical Workers).
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.