Will the Trump tax plan eliminate the estate tax? Yes, the Trump tax plan would eliminate the gift tax, estate tax and generation-skipping transfer tax, and replace those transfer taxes with a capital gain tax on appreciated assets inherited from the decedent. JEHM Wealth & Retirement points out that this would completely change how estate planning is done by replacing the current emphasis on reduction of transfer tax to one which emphasizes planning for the reduction of capital gain taxes.
If the Trump proposals become law, current wills and trusts in larger estates would have to be rewritten because they typically provide for formula bequests based on the estate tax law, which would no longer make sense if estate taxes were repealed. The Trump plan would also render moot the recent proposed regulations issued by the IRS which would eliminate valuation discounts for interests in family entities.
Under current law, every individual has an estate tax exemption of $5 million, adjusted annually for inflation. In 2016, the estate tax exemption adjusted for inflation is $5.45 million. Everything over the exemption is taxed at a rate of 40 percent. Under current law, the income tax basis on the decedent’s appreciated property for determining capital gains steps up to the fair market value at death. For example, if the decedent paid $100 for an asset and died when the asset was worth $1,000, the heirs can sell the asset for $1,000 without incurring a capital gain because the cost basis of the asset would step up to $1,000 at the decedent’s death.
Although the Trump proposal would eliminate transfer taxes at death, it would also eliminate the stepped-up basis and replace it with a carryover of the decedent’s basis. In other words, if the decedent paid $100 for an asset and died when it had a fair market value of $1,000, if the heirs sold it for $1,000, they would have a capital gain of $900 because they would continue to have the decedent’s cost basis in the asset of $100 after the decedent’s death. However, under the Trump plan, there would be a $5 million exemption on capital gains on property received from the decedent.
The proposed plan would necessitate rewriting wills and trusts in many or the larger estates. Typically, in such estates formula bequests of a portion of the estate sheltered by the estate tax exemption available at the time of death is left to a trust or heir, and the rest is left to the surviving spouse. Bequests to the surviving spouses are not subject to estate tax, so under such a plan no estate tax is due upon the death of the first spouse to pass away. If the estate tax is eliminated, then these formula bequests based on the amount of the estate tax exemption available at the time of the decedent’s death make no sense because there will be no estate tax and no estate tax exemption. All of these types of wills will have to be redrafted.
Under the proposed law, although there will be no estate tax, there will be a need for planning for capital gain purposes. There will likely be a complex set of rules for the allocation of the $5 million capital gain exemption among the decedent’s assets, and the decedent’s assets will have to be valued. Consideration will have to be given to which assets of the decedent may be sold, and the timing of the sales will have to be addressed to minimize gains.
If the Trump proposal becomes law, the recently issued IRS proposed regulations, which eliminate valuation discounts for certain family entities, will become irrelevant. These proposed regulations are among the most recent developments in estate planning and could become final and effective as early as next year. The proposed elimination of the transfer tax will make all of this moot.
Although the Trump plan will eliminate estate taxes, the necessity for estate planning for tax purposes will not be eliminated. Instead the emphasis will be changed from one of planning for minimization of estate taxes to one of planning for the minimization of capital gains. It may also make the U.S. and Florida in particular a more attractive place to establish residency in the case of wealthy foreign individuals who come from countries that have a high inheritance tax.
Eric and Jennifer Lahaie
JEHM Wealth & Retirement