December 6, 2016
The familiar old adage is that there is nothing certain except death and taxes. But will we finally see the death of the estate tax now that Donald J. Trump has won the White House?
As part of his presidential campaign, Trump proposed eliminating the estate tax. The Republicans have for many years wanted to end it, and now they control both the Senate and the House of Representatives. Despite this collective control, however, the permanent repeal of the estate tax is not certain, leading to more questions than answers at this point. Here are some potential scenarios to consider.
Currently for 2017, estates valued at more than $5.49 million ($10.98 million for married couples) will be taxed at 40% upon the estate owner’s death. Wealthy families have traditionally relied on careful estate planning, often putting assets in trusts and gifting property, to reduce their tax burden.
While the House will likely propose to repeal the estate tax next year, and Trump is unlikely to veto any such bill passed, the Senate must also approve it. Although the Republicans currently control the Senate with a 51 to 48 majority, Senate rules require a 60-vote majority to overcome a potential Democratic filibuster, and thereby force a vote on any bill that would permanently end the estate tax. While the Senate Democrats could agree to compromise and end the estate tax, that’s unlikely as the tax policy divide between the Republicans and Democrats remains strong.
Another option is a “budget reconciliation” bill, which can be passed with a simple majority. But the 30-year-old “Byrd Rule,” named after West Virginia Sen. Robert Byrd, prevents budget reconciliation bills that would extend the deficit more than 10 years. So any bill to repeal the estate tax would have to sunset in 10 years. That’s exactly what happened when President George W. Bush gradually “eliminated” the estate tax in 2001, only to see it return in 2011.
Even if Congress passes a bill to repeal the estate tax, it is uncertain what will happen to the current income tax rule that provides a fair market value increase in basis for assets transferred at death. In simple terms, what this means is if you hold property that you purchased for $50,000, and it increased in value to $100,000 at the time of your death, your heirs would avoid capital gains tax on the $50,000 increase when the asset is sold. But, if your estate is large enough to be subject to estate tax, the 40% tax would apply.
Trump’s campaign proposed eliminating the “step-up in basis” rule as the corollary to estate tax repeal, so it might mean taxpayers with appreciated assets effectively are exchanging estate tax for future income taxes. In states like California, where the combined state and federal capital gains tax rate can reach 34%, this may not result in great overall tax savings. One option that has been proposed by some Republican lawmakers is to require immediate recognition of such appreciation at death. In that case, transferring appreciated assets to heirs or in trust for heirs will continue to be beneficial to avoid such immediate capital gains tax at death.
It doesn’t really matter if estate tax legislation is passed today if there is the strong potential it could change tomorrow.
Regardless of what happens with the step-up in basis rule, nothing prevents a subsequent Democratic Congress or president from reinstating the estate tax. In this election, both Democratic presidential candidates advocated keeping the estate tax and even proposed increasing the top rate to as much as 65%. This would be even more likely to happen if an estate tax elimination bill sunsets in 10 years when a new administration controls Congress. The bottom line is that the estate tax has been repealed and reenacted by Congress several times since its inception a century ago. Therefore, unless someone is likely to pass away in the near future, a bill today repealing the estate tax may have little or no effect on whether a taxpayer is subject to estate tax at death.
To prevent estate tax avoidance through gifts, Congress imposes a gift tax on lifetime transfers. While unclear, it is likely that some form of gift tax would remain, as was the case when there was no estate tax in 2010. Without a gift tax, appreciated assets being sold could be gifted to children in lower income tax brackets and then gifted back post-sale too easily. Likewise, assets could be gifted into creditor protected trusts, such as spousal lead access trusts, without limit. If the gift tax is retained and you want to pass significant amounts to your children before death, some tax planning will still be necessary.
Lastly, even if the Republican majority were able to pass permanent repeal of both federal gift and estate taxes and retain the step-up in basis at death, it doesn’t mean estate planning is unnecessary. Individual states are free to impose their own estate or inheritance tax. Today, more than 19 states already have some form of estate or inheritance tax, with rates as high as 16% on amounts over $1 million. If you reside or own property in one of these states, or in a state that later adopts an estate tax before the you pass away, then estate tax planning will still be important.
Remember, estate tax is only imposed when you die. It doesn’t really matter if estate tax legislation is passed today if there is the strong potential it could change tomorrow. As a result, while it would seem the possibility of estate tax repeal under a Republican-controlled House, Senate and presidency would provide clarity, it really creates even more planning uncertainty.
Given this continued uncertainty, how should you plan for the future? In most circumstances, holding assets in trust for your heirs will have no negative consequences. But, it should provide tax benefits if an estate tax does later apply or there is recognition of gain on assets when you pass away. Regardless, transferring assets to a trust can provide non-tax benefits as well, such as asset protection. The only exception would be if Congress permanently repealed the estate tax and continued to allow a full step-up in basis at death. In that case, if transfers were previously made to “grantor trusts,” then you could benefit by exchanging appreciated assets held by the trust with lesser appreciated property.
If you’re not sure whether to engage in estate tax planning, you might be inclined to take a wait-and-see approach until some legislation is proposed. But, with the possibility of future reenactment of the estate tax, it would be beneficial to consult a wealth advisor and review your current plan to ensure it still works for you.
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