January 24, 2017
November’s election of Donald Trump into the presidency carries with it enormous ramifications for corporate and individual finances. Apart from the plans to reduce corporate tax rates to as low as 15 percent, the incoming administration has proposed significant personal tax changes. One of the most contentious proposals, and political football for both Republicans and Democrats alike, is the estate or “death tax”.
First some basics. The Internal Revenue Service (IRS)(2016) defines the estate tax as “a tax on your right to transfer property at your death”. The beginning point is the “gross estate” which is tallied using the fair market value of all assets, including the investment portfolio, along with any prior years’ gift transfers that may have exceeded the annual excluded amounts (currently $14,000 per year). After accounting for deductions, which may include charitable, mortgages, debt, and the “unified estate and gift tax exemption”, a final “net asset” figure is computed for consideration of applying the estate tax, currently 40 percent.
The unified gift tax exemption for 2017 is $5.49 million for individuals and $10.98 million for married couples. As an example, consider the single individual whose net estate is valued at $6.49 million. The $1 million above the exemption is subject to the 40 percent rate, resulting in a $400,000 estate tax paid to the IRS.
Trump and the Republican Congress are looking at a tax plan that would completely eliminate the estate tax. President-elect Trump has recommended repealing estate taxes and imposing capital gains taxes on assets left to heirs in excess of $10 million. The current House Blueprint proposes repealing estate taxes with no suggestion of a replacement capital gains tax, and no suggestion for eliminating the step-up basis to fair market value that is currently available at death. It will be interesting to see what the ultimate proposals are and what trade-offs are negotiated in trying to pass legislation.
In debating and deciding the advantages of the arguments for zeroing out the death tax, maintaining its current level, or continuing at a varying percentage going forward, a few interesting points are important to understand.
According to C. Huang and C. Cho of the Center on Budget and Policy Priorities (2016):
- Two of every 1,000 estates face the estate tax and 99.8 percent of estates owe no estate tax at all, according to the Joint Committee on Taxation.
- The estate tax will generate about $275 billion over 2017-2026 under current law, according to the Congressional Budget Office. This is less than one percent of federal revenue over the period.
Due to the significant increases in the exemption amount over time, much of the financial burden surrounding estates affected by the levy has been lifted over the past 15 years. In 2001, the exemption level for an individual estate was $675,000 versus the current $5.49 million level. When in 2001, 100,000 estates were subject to the estate tax, now less than 10,000 annually exceed the threshold.
Discussions regarding the social, economic, and political objectives of the estate tax are important, as they concern governing principles in our country: wealth distribution, entrepreneurship, fairness, and equity. However, these are as much policy themes as they are philosophies. The majority of concern for individuals and families are the financial impacts of the estate tax and changes to its implementation.
A zero tax rate on estates could certainly alleviate financial stress for heirs. However, what if step-up provisions were eliminated in conjunction and assets were subject to historical basis for the capital gains tax? This is but one of a host of topics associated with not just the estate tax but, more broadly, estate planning. The reality is that the estate tax is only a very small piece of a larger puzzle of trust and estate planning issues that must be addressed. Other issues include asset protection, financial oversight, health care finances, divorce considerations, long-term care choices and medical decisions among others.
Risk mitigation to confront these challenges must be a priority for individuals and families who desire the next generation to benefit from the hard work and effort put forth to build a valuable estate. Perhaps an even more vital part of proper and thorough estate planning is peace of mind. There is comfort in knowing that time and thoughtful consideration to put decisions in place are now setting the stage for greater control, certainty, and security in the future. Even if in 2017 an estate tax deal is signed into law and the estate tax is eliminated, the need to properly plan for the future transfer of assets to beneficiaries does not disappear.