Wealthy Benefit From Estate Tax Changes, AMT Repeal in House Bill (Correct)

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By Allyson Versprille

The House Republican tax reform bill includes several provisions that affect the wealthiest Americans—changes to estate tax being some of those most closely scrutinized by advisers.

The bill ( H.R. 1), released Nov. 2, would immediately double the federal estate and generation-skipping transfer tax exemption but wouldn’t fully repeal the taxes until Jan. 1, 2024. “The problem with a delayed estate tax repeal is that you cannot plan for the date that you will die,” said Pam Lucina, executive director of BNY Mellon Wealth Management’s Advice, Planning and Fiduciary Services.

“Therefore, people will have to create flexible plans that contemplate both having an estate tax and not having one,” she said, adding that her firm recommends taking these steps regardless of whether the House Republicans tax reform bill becomes law, because “permanent legislation is only permanent until the next Congress.”

The estate tax—often labeled the “death tax” by its conservative opponents—currently applies a 40 percent tax rate to estates worth more than $5.49 million for individuals, or $10.98 million for married couples. Those figures would initially be doubled under the House bill.

Under the current exemption amount, the Tax Policy Center estimates estate tax liability in 2017 will total close to $20 billion, with the top 10 percent of income earners paying 88 percent of the total and the richest 0.1 percent paying 27 percent.

“For the really wealthy, using the increased exclusion amounts as soon as possible in long-term” generation-skipping transfer trusts “will be the order of the day, before the government flips again,” Richard S. Franklin, a member at Franklin Karibjanian & Law PLLC, told Bloomberg Tax, anticipating that, at some point, the estate tax may return under a different administration or Congress.

Basis Step-Up Stays

The House bill would maintain a favorite income tax perk known as the “basis step-up.” Under this provision, the tax basis of an asset held until death is readjusted to fair market value, permitting heirs to sell the asset without realizing any taxable gains.

“Maintaining the basis step-up and eliminating the estate tax would be an unexpected windfall,” Lucina told Bloomberg Tax in an email.

In 2010, when the estate tax was temporarily repealed as a result of the 2001 Bush tax cuts, basis step-up was replaced by a modified carryover basis regime, which gave inheritors up to $1.3 million in stepped-up basis and allowed surviving spouses to take an additional $3 million in stepped-up basis. However, outside of those exemptions, basis would be carried over.

Retaining basis step-up may encourage people to hold onto their assets until death to reap the benefits of estate tax repeal and absence of capital gains on the appreciation at death, Lucina said.

“However, the ultra wealthy may want to consider making gifts up to the increased exemption amount next year to flexible trusts that provide creditor protection for families,” she said. Under the House bill, starting Jan. 1, 2018, the lifetime gift tax exemption amount would double to $10 million, indexed for inflation. Flexible creditor protection “trusts can be drafted to provide that low basis assets may be swapped with higher basis assets in the future, yet the value will be excluded from their estate in case the estate tax is ever reinstated,” Lucina said.

In addition to the higher lifetime exemption amount for gifts, the top tax rate would decrease in 2024 to 35 percent from 40 percent. “Most states now allow the modification of trusts, including modifications for tax purposes to address unforeseen tax law changes,” Robert J. Lord, a business and tax attorney based in Phoenix, told Bloomberg Tax in an email. Because of the changes to the gift tax, “we’ll have people with estates in the sub $22M range for a married couple going back and modifying trusts they set up to establish complete gifts and taking steps to create inclusion in their estate.”

AMT Repealed

The House bill would repeal the individual alternative minimum tax (AMT)—a tax levied on certain individuals with exemptions or special circumstances that allow them to pay lower standard income tax.

David M. Lehn, a partner in the private client and tax team at Withers Bergman LLP, said elimination of the AMT is a potentially significant benefit for well-off taxpayers. “For many high earners with substantial deductions, the AMT became an ‘additional tax,’” he told Bloomberg Tax in an email.

The AMT requires certain taxpayers to calculate their liability twice—once under the rules for the regular income tax and once under the AMT rules—and then pay the higher amount.

“High-income earners would benefit from the elimination of the alternative minimum tax, which almost exclusively affects households making over $200,000 of income,” said Brad Dillon, a vice president and senior wealth planner in the New York office of Brown Brothers Harriman.

The Tax Policy Center says the AMT “primarily affects well-off households, but not those with the very highest incomes. It is also more likely to hit taxpayers with large families, those who are married, and those who live in high-tax states."

Carried Interest Retained

The House bill would retain the carried interest, a favorite tax break among investment fund managers.

President Donald Trump publicly criticized the tax break during his presidential campaign, and as recently as September, White House chief economic adviser Gary Cohn said Trump’s intent was to eliminate the benefit.

Carried interest is the portion of investment funds’ returns that is paid to investment managers as compensation. It is now taxed as capital gains, at a rate as low as 23.8 percent. The top rate for individual income tax is 39.6 percent.

“It is possible that carried interest reforms are being saved as a future concession to moderate Democrats they seek to win over,” Brian Riedl, a senior fellow in budget, tax, and economics at the conservative-leaning Manhattan Institute for Policy Research, told Bloomberg Tax in an email.

Offsetting the Positives

Offsetting the positive changes for wealthy taxpayers are the $10,000 cap on the state and local property tax deduction, repeal of the itemized deduction for state and local income or sales taxes, and a lower mortgage interest deduction cap, Lehn said. The bill maintains the widely used deduction for new home loans of $500,000 or less, a sharp reduction from the current $1 million cap.

Additionally, the House bill limits the ability of a business to deduct the cost of an executive’s annual compensation. Under current law, businesses can write off as much as $1 million in compensation expenses for chief executive officers and four other top-paid bosses, plus any amount beyond that if it’s tied to performance targets. The Republican bill would keep the $1 million threshold but eliminate the exemption for pay linked to results, denying companies the option to write off large equity awards.

“This means more of this compensation would be subject to both the 20 percent corporate tax rate and the 39.6 percent individual tax rate,” Riedl said.

The House bill maintains the top individual income tax bracket of 39.6 percent. The September framework originally sought to eliminate the top bracket but suggested it may be added back in.

“While lower marginal tax rates are generally pro-growth, the difference between 35 and 39.6 percent for millionaires is not large—especially if most small business income and investment income is taxed at a lower rate,” Riedl said. “With a limited $1.5 trillion pot of savings, cutting tax rates for business investment is more important.”

Dillon told Bloomberg Tax in an email that despite the highest marginal tax bracket remaining at 39.6 percent, “higher-income earners would receive the benefit of the lower marginal brackets.”

“For example, for married joint filers, income earned between $200,000 and $1 million would be taxed at 35%, whereas under current law, the income earned over $470,700 would be taxed at 39.6%. This change alone would amount to a tax savings of over $20,000 for a couple earning $1 million in any given tax year,” he said.

(Last section updated to correct description of changes to the state and local tax deduction)

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

For More Information

A section-by-section summary of the bill is at http://src.bna.com/tVB.Text of the House bill is at http://src.bna.com/tVu.

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