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Sept. 19 — The newest version of Donald Trump's tax plan calls for a repeal of the estate tax, but applies a tax on capital gains held until death to recoup some of that revenue.
The proposal has some in the estate planning industry wondering if the change would really be most beneficial to estate owners.
The Republican presidential candidate's most recent tax overhaul platform says his proposal would “repeal the death tax, but capital gains held until death will be subject to tax, with the first $10 million tax-free as under current law to exempt small businesses and family farms.” The plan says to prevent abuse of this provision, contributions of appreciated assets into private charities established by the decedent or the decedent's relatives would be disallowed.
What that means “is the estate tax is out but you sacrifice step-up basis,” Alan Cole, an economist with the Center for Federal Tax Policy at the Tax Foundation, a right-leaning Washington think tank, told Bloomberg BNA Sept. 19. Under current policy, assets held in an estate until death receive a step-up in basis to fair market value at the decedent's date of death. While the decedent's estate owes an estate tax, it doesn't have to pay tax on unrealized capital gains and the heirs only pay taxes on future gains when they sell the assets.
Trump's platform doesn't mention whether the $10 million exemption is per individual or per married couple. The campaign didn't respond to a Bloomberg BNA request for comment.
A Sept. 19 Tax Foundation analysis of the tax plan assumes that the $10 million exemption is applied per couple—$5 million per individual—according to Cole, the report's author.
Cole said there are several advantages to the Trump plan, but others noted potential downsides.
Palmer Schoening, chairman of the Family Business Coalition, said the group's top priority is to repeal the “estate tax however possible.” However, the coalition supports House Ways and Means Committee Chairman Kevin Brady's (R-Texas) 2015 bill (H.R. 1105), which calls for a repeal of the estate tax but keeps the stepped-up basis benefit entirely intact, he said.
“The step-up in basis is particularly important for family-owned ranches and farms,” he said. “You can have a case where the valuation has increased dramatically throughout many generations and the hit from the capital gains could in some cases be even greater than the estate tax hit.”
Schoening said the $10 million exemption does provide relief for a majority of small businesses. However, there are potentially some cases in which family-owned farms and ranches that have rapidly appreciating assets could be impacted.
“Since the '60s for example Iowa farm land has appreciated 3100 percent and similar farm land appreciation has taken place in other states across the country,” he said in a follow-up e-mail Sept. 19. “Many large distributors, manufacturers, and other multigenerational private businesses started with almost no basis and have grown in value while staying in the family.”
Schoening said the coalition won't know for sure what the precise impact will be until actual legislative language on the Trump capital gains provision is produced.
Stephen Dyer, a partner at Baker Botts LLP, said he anticipates similar problems. While the $10 million exemption removes the tax liability for many people, “there are still an awful lot of people who are worth more than that number,” he said. For some of those individuals, eliminating the step-up in basis would be worse, and “it's really administrably cumbersome,” Dyer told Bloomberg BNA Sept. 19.
According to Cole, the Tax Foundation doesn't interpret the Trump plan as levying taxes on capital gains at death “because that doesn’t really sit with the spirit of getting rid of the death tax.” Instead, the foundation expects that the plan would establish a carryover basis on those gains.
Dyer pointed out that the carryover basis idea seems to resemble the solution implemented in 2010 after the estate tax was repealed under the Economic Growth and Tax Relief Reconciliation Act of 2001. The estate tax was replaced by the modified carryover basis rules, which gave inheritors up to $1.3 million in stepped-up basis and surviving spouses could take an additional $3 million in stepped-up basis. However, outside of those exemptions, basis would be carried over.
In December 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act was enacted, modifying and extending the pre-2010 estate and gift tax provisions through 2012. The government allowed 2010 decedents to either retroactively elect liability under the new estate tax regime or under the 2010 carryover basis regime.
Trump's proposal “sounds very similar to the 2010 solution, which when we got to 2010, we undid it at the end of the year,” Dyer said. “We just had that, and we just got rid of it,” he emphasized.
Schoening also suggested that it sounded like a similar proposal, but noted that having a permanent choice between an estate tax or capital gains tax—mirrored after 2010—might be a better compromise for small business owners rather than forcing them to pay either tax. He said the Family Business Coalition would welcome such a change if full elimination of the estate tax, while maintaining the step-up benefit, isn't an option.
If the exemption in the Trump proposal is designated per couple as assumed by the Tax Foundation—meaning the individual exclusion is $5 million—then “I think it’s the same thing we have today by a different name,” said James Hogan, managing director of Andersen Tax LLP. He said the exemption would be so similar to current estate tax exclusions that the same people would likely be impacted. For 2016, the threshold is $5.45 million, which will be inflation-adjusted to $5.49 million in 2017, according to a Sept. 16 Bloomberg BNA report.
“We’re basically back in the same boat and of course this would have a potential impact on those individuals and couples with family businesses that have values over $10 million,” Hogan told Bloomberg BNA Sept. 19. “When the individual dies the first $10 million would be excluded, but there would be a capital gains tax on the appreciation on the excess.”
However, Hogan said this specific proposal doesn't exist in a vacuum, and mentioned that a lot of information is missing from Trump's plan. “You have to piece it with any other proposals,” he said. “My question would be: Is he going to repeal the gift tax provisions” too?
The Tax Foundation analysis assumed gift taxes would also be repealed. The report found that Trump's plan to eliminate the estate tax would cut federal revenue by $240 billion based on a static estimate and by $24 billion based on a dynamic estimate from 2016 to 2025. The dynamic estimate takes into account the proposal within the context of the rest of Trump's plan, which is why the second estimate is much lower, Cole said in a follow-up e-mail Sept. 19. “The current version of the Taxes and Growth model sees the estate tax as highly inefficient because of its high rate and its narrow base on capital accumulation,” he said.
Additionally, according to the foundation, both reductions would be slightly counteracted by revenue raised from the capital gains basis change. Under the static model, the change would increase revenue by $48 billion, and under the dynamic model that number would increase by $27 billion.
Like Hogan, Cole said Trump's proposal would likely impact the same number of people currently subject to the estate tax. “The exemption is at the same level as the estate tax so it should affect the same number of people,” he said. “Essentially, people who had the estate tax to worry about previously now have to do carryover basis.”
Cole compared the Trump plan to a proposal touted by former Republican presidential hopeful Jeb Bush.
According to a December 2015 Tax Policy Center analysis of the plan, Bush sought to repeal the estate and gift taxes while also limiting the step-up in basis for capital gains to $5 million per decedent, indexed for inflation. For example, the limit in 2015 would be $5.43 million—the same as the estate tax exemption for that year.
“The Bush plan would limit step-up in basis to the current threshold for the estate tax, which is $5.43 million in 2015 (although spouses would continue to receive unlimited step-up),” the report said. “Heirs or estate administrators would have to choose which assets would receive step-up treatment and report the election to the Internal Revenue Service to claim the option,” it said.
All other assets would be passed on to heirs with the decedent’s basis, also known as carryover basis, the Tax Policy Center said. “Even with the limited carryover basis regime, only inherited gains from the largest estates would be subject to tax,” the report said.
Replacing the estate and gift tax with carryover basis for capital gains would have a relatively “modest” effect on revenue, reducing them by $185 billion from 2016 to 2026, the report said.
Cole said he sees the Trump plan as having several advantages, the first being the support it would garner from Republicans on Capitol Hill.
In “political terms it’s a popular thing to promise to people,” he said. “People don’t really like the idea of the estate tax, or at least a lot of people don’t.”
Cole also said the Tax Foundation considers taxes on accumulated wealth as discouraging capital formation. Estates are invested in structures, buildings and farms that the U.S. would benefit from maintaining, he said.
“If you encourage people to spend down their money in retirement rather than passing it on, you reduce the total capital stock. So that’s why we show the estate tax as a bit of a drag on growth,” he said.
Additionally, improvements in modern technology would make it easier for estates to calculate carryover basis, Cole said. “It’s not like you have to look for these documentations on paper of the transactions where your relative bought some shares of something years ago. It’s all on computers. So carryover basis is a pretty serious modern proposal.”
Cole doesn't anticipate many negatives resulting from the latest Trump plan.
“Obviously, the people who have to pay the carryover basis taxes but didn’t previously, they wouldn’t like that. But such is life. Taxes are never liked by the people paying them.”
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The Tax Foundation's analysis of Trump's tax overhaul platform is at http://src.bna.com/iI6.
Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.
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