Impending Estate Tax Repeal: Implications for Succession Planning

CohnRez-Matak-blog

The presidential election has generated intense buzz among estate tax planning professionals who are wondering whether, and how quickly, the Trump Administration might eliminate the federal estate tax. President Trump has made no secret of his plan to repeal the federal estate tax, which currently stands at 40% on estates over $5.45 million.  House Speaker Paul Ryan has already proffered a tax plan that repeals the estate tax, and Senate Majority Leader Mitch McConnell has signaled his agreement with repeal.

Estate tax reform seems to be all but a fait accompli, with the only questions remaining: How much, and how soon?

Estate Tax Repeal? What About the Gift Tax?

The Administration has several other priorities on its agenda for the first 100 days.  While there has been speculation that tax law changes are not expected to be effective until January 1, 2018, it is conceivable that our new federal government could accomplish estate tax repeal fairly quickly.

While the Republican platform clearly includes estate tax repeal, the fate of the federal gift tax remains uncertain. The current wisdom among leading wealth transfer strategists is that the federal gift tax may be retained in some form to prevent wealthy taxpayers from purging their estates to avoid an immediate capital gains tax on assets with a combined value exceeding $10 million at death. Further, if the Treasury is successful in limiting the use of discounts on gift transfers, taxpayers may find it more difficult to leverage wealth from their estates so their heirs may defer capital gains tax until the actual sale of inherited assets. This could prove problematic, particularly for business owners with fairly illiquid estates.

The Devil’s In the Details

While it is true that then-candidate Trump proposed a complete repeal of the federal estate tax, his plan required a capital gains tax of 20% at death on assets over $10 million.  His proposal also called for the elimination of the automatic basis step-up of a decedent’s assets at death.

In other words, it appears that:

  • For estates worth more than $10 million, there will be an immediate capital gains tax due on the difference between the date of death value and the decedent’s basis in the asset.
  • For estates under $10 million, heirs will have to pay capital gains tax on the sale of any inherited asset to the extent that the sales price is greater than the decedent’s basis in the asset at death.

In other words, the current proposal appears to eliminate the taxpayer-friendly rule that permits the basis of an asset to be adjusted to the date of death value, also known as the automatic step-up.  Despite the uncertainty surrounding the fate of the federal estate tax, here are some important planning considerations to consider now:
Estate Tax Repeal? What About the Gift Tax?

The Administration has several other priorities on its agenda for the first 100 days.  While there has been speculation that tax law changes are not expected to be effective until January 1, 2018, it is conceivable that our new federal government could accomplish estate tax repeal fairly quickly.

While the Republican platform clearly includes estate tax repeal, the fate of the federal gift tax remains uncertain. The current wisdom among leading wealth transfer strategists is that the federal gift tax may be retained to prevent wealthy taxpayers from purging their estates to avoid the immediate capital gains tax at death on assets with a combined value exceeding $10 million at death.  Gift tax would also prevent wealthy taxpayers from shifting assets to taxpayers in a lower tax bracket, which could have a deleterious effect on federal and state income tax collection efforts.

Further, if the Treasury is successful in limiting the use of discounts on gift transfers, taxpayers may find it more difficult to leverage wealth from their estates so their heirs may defer capital gains tax until the actual sale of inherited assets. This could prove problematic, particularly for business owners with fairly illiquid estates.

Despite the uncertainty surrounding the fate of the federal estate and gift taxes, here are some important planning considerations to consider now:

  • Transferring assets to trusts is still important for asset protection and business succession purposes.  Trusts also serve an important function in ensuring that assets will be devised as the owner directs.
  • Transferring an asset into trust now before death would help to defer the any capital gains tax which would be imposed at death under the Trump plan because the asset would not be in the estate.  In this way, the taxpayer’s heirs could defer the tax on any gain between the transferor’s basis and the date of death value until the asset is actually sold.  This could be particularly important for closely held business owners who might be unable to liquidate assets quickly in order to pay taxes.
  • There are still several states that have an estate or inheritance tax.  Taxpayers should continue to plan in order to avoid those state taxes.  A repeal of the federal estate tax would mean that there would be no federal benefit to paying state estate or inheritance taxes.
  •  In August of 2016, Treasury proposed regulations that would limit the ability of closely held business owners to transfer business interests, specifically by eliminating valuation discounts of minority interests.  While adoption of these proposed regulations has been on hold since the election, there is still a chance that Treasury will adopt some form of those regulations.  It is crucial for closely held business owners to be prepared for the possibility that discounts could be limited in the future.  Anyone who was in the process of planning to make transfers before the election should likely continue that process.
  • Insurance planning remains relevant in order to ensure that there will be sufficient liquidity.  Whether or not there is an estate tax, it is recommended that life insurance always be held within a life insurance trust, primarily for asset protection purposes.

The proposed estate tax repeal would have to pass a filibuster-proof majority in the Senate in order to avoid automatically expiring in 10 years. While predicting the future is a fool’s errand, the rhetoric on Capitol Hill appears to be signaling that both the President’s and the House proposals would need major modifications in order to obtain 60 votes in the Senate. In short, it is difficult to envision a permanent repeal of the federal estate tax any time soon.

Business owners are well advised to continue with plans to protect and preserve wealth for future generations and to ensure the succession of their family businesses.

For additional information, please contact Joy Matak, National Trusts and Estates Practice Co-Leader for CohnReznick, at Joy.Matak@CohnReznick.com. Click here to learn more about CohnReznick’s National Trust and Estates Practice.

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