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President-elect Donald Trump has promised to introduce a tax overhaul plan that includes estate tax repeal as a priority in his first 100 days, but wealth planners say there are several questions that must be addressed before repeal becomes reality.
Many of the details on estate tax repeal have yet to be hashed out. Neither Trump nor Republican lawmakers have disclosed when such a repeal might take effect, whether the gift tax will continue to exist or what the capital gains tax Trump proposed on the campaign trail might look like.
The lack of certainty has had a “chilling” effect on the estate planning world, Cynda C. Ottaway, president of the American College of Trust and Estate Counsel, told Bloomberg BNA. As a planner, to clients “you’ve got to say, ‘All right, keep your plan in place and stay healthy,’ because you don’t know what’s going to happen,” she said.
“There are just so many unknowns,” she said.
The top question on many practitioners’ minds is whether estate tax repeal will actually occur, and if so, whether it will be permanent.
The June House GOP agenda—" A Better Way: Our Vision for a Confident America"—calls for repeal, as did Trump’s tax plan during the campaign. But even if repeal is included in the anticipated tax overhaul package, to pass through the Senate, Republicans need 60 votes, which may prove difficult, wealth planners said. Republicans control 52 of the 100 seats in the Senate following the November elections.
Repeal could get passed through a procedural pathway known as reconciliation, which would allow Republicans to push the change through with a simple majority. But that route comes with strings attached. To use reconciliation, Republicans would need a budget resolution first, which could take until March or April. Additionally, legislation passed through reconciliation can’t expand the federal deficit outside the 10-year budget window.
The Economic Growth and Tax Relief Reconciliation Act of 2001 was passed using reconciliation under former President George W. Bush, which led to the temporary repeal of the estate tax in 2010, only to be reinstated the following year. This temporary repeal created a lot of uncertainty for both taxpayers and planners.
Ottaway said that if Congress passed repeal again in that type of “sunset law,” clients may want to consider establishing two estate plans. “One plan would be followed if there is no estate tax upon the death and another that would be followed if the estate tax is reinstated,” she said.
Both Trump’s campaign plan and the House blueprint are silent on the fate of the gift tax.
“You would think if there’s repeal of the estate tax, they would also address the gift tax at the same time, but maybe not,” said John Bergner, a shareholder and chair of the Wealth Preservation Practice Group in the Dallas office of Winstead PC.
Planners don’t know what is going to happen to the gift tax, Bergner said. Even if lawmakers decide to retain it, there is no certainty regarding what the rate or exemption amount will be, he said. Currently, there is an annual gift tax exclusion of $14,000 per donee. That is separate from the lifetime estate and gift tax exemption of $5.45 million, which will increase to $5.49 million in 2017. Like the estate tax, the top gift tax rate is 40 percent.
J. Scot Kirkpatrick, a shareholder at Chamberlain, Hrdlicka, White, Williams & Aughtry, said it is unlikely that the gift tax will be eliminated, but it might change.
“The gift tax protects the state income tax system because if we didn’t have a gift tax, I could in theory set up a trust and move everything to Texas and Florida or some other place that doesn’t have an income tax, sell it over there,” and then pull back the funds to wherever they are needed, said Kirkpatrick, who heads the Trust and Estates Practice Group in his firm’s Atlanta office.
Another uncertainty is whether the estate tax would be replaced by a capital gains tax for assets held until death and valued at more than $10 million, which Trump proposed on the campaign trail. The House blueprint doesn’t include this detail.
In his proposal, Trump doesn’t specify whether the $10 million exemption is per person, per family or per couple, which Ottaway said she would like clarified. “As an advocate for the taxpayer, I’m hoping it would be per person,” she said.
Additionally, if there is a capital gains tax, it is unclear whether it would be triggered automatically upon a decedent’s death or when the beneficiaries dispose of the assets, Bergner said.
The first policy would be similar to the system used in Canada. Instead of an inheritance tax, when a person dies the government treats the estate as a sale, unless it is inherited by the surviving spouse or common-law partner, in which case certain exceptions are possible.
“So there’s a capital gains tax owed at death by the decedent on his final income tax return,” Bergner said of the Canadian system. It is difficult to determine if Trump was proposing a similar policy, he said.
Practitioners also expressed confusion about how—or if—a popular income tax benefit known as basis step-up would apply under a capital gains system.
Currently, when a person dies, the estate’s heirs are entitled to a stepped-up basis, in which an appreciated asset held until the owner’s death is stepped-up to the fair market value at the time of inheritance. This means the heirs avoid paying capital gains tax on the appreciation that occurs before the asset is transferred.
Because Trump has proposed a $10 million exemption, “do we get a step-up in basis on the first $10 million?” Bergner said. “There’s total uncertainty there.”
Ottaway noted a previous failed attempt to eliminate stepped-up basis and replace it with a carryover basis regime—in which heirs retain the basis of the decedent—through the Tax Reform Act of 1976.
“There was such an outcry that all of a sudden you didn’t have this death event to clean up everything,” she said. “It really tends to be helpful in that at least once a generation, the next generation gets to start over with a clean slate and get a new stepped-up basis.”
Trump’s campaign proposal said that capital gains held until death and valued over $10 million “will be subject to tax to exempt small businesses and family farms.”
Bergner said the ambiguity of that statement raises questions about whether Trump meant to apply the $10 million exemption only to small businesses and family farms, or if it also encompasses taxpayers who have marketable securities and cash.
“My guess is this was probably meant to be all-inclusive, not exclusive,” Kirkpatrick said. Because the current estate tax exemption is nearly $11 million—the amount of exclusion allowed per couple—it is likely that lawmakers would “come up with something similar” for the capital gains tax, he said.
Kirkpatrick said it is possible lawmakers could establish a system where the capital gains tax is automatically imposed at death on liquid assets, but for farms and small businesses the tax isn’t triggered until those assets are sold.
“I don’t like that idea much,” he said. “I think everyone should be treated the same.”
Other language in the Trump proposal that has given attorneys pause is this sentence: “To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives will be disallowed.”
“If there isn’t an estate tax, I assume they mean disallowed for the income tax deduction, but you typically don’t get an income tax deduction for transfers at death in any event,” Bergner said. “It’s hard for me to understand. Maybe they’re saying if it’s over the $10 million, the gain is still taxed if it goes to a family foundation. You just have to speculate what they’re suggesting the law would be.”
Kirkpatrick said that sentence had him “scratching his head.”
“I’m not really sure of the bad thing that’s supposedly happening that we need some special rule” against, he said.
Regardless of what the new law looks like, Kirkpatrick said he is making sure clients are prepared for the possibility of facing an estate tax in the future.
“If history shows anything, the pendulum’s going to swing back the other way at some point. It may be another decade, or another two or three, but it’s coming back,” he said. “And what better time to be ready for it than when it doesn’t exist, because as they say, the only things that are certain are death and taxes.”
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