FUTURE OF THE FEDERAL ESTATE TAX?
The election of Donald Trump and a solidly-Republican Congress has fueled great speculation about potential federal tax law changes. We have long believed that the federal estate tax might one day be repealed and that our younger clients, in particular, should at least consider that possibility before engaging in complex and administratively burdensome estate tax reduction techniques. Although repeal now appears as close as it ever has, the end result remains uncertain. As the process unfolds, here are some issues that we will be watching:
Where Will Estate Tax Repeal Fit among Tax-Cutting Priorities?
In addition to estate tax repeal, President-Elect Trump and the Republican Congress have campaigned on reducing corporate income tax rates, reducing individual income tax rates, repealing the Medicare surtax, and overhauling the tax code. Historically, federal estate tax legislation has piggybacked on broader federal tax legislation. If budget balancing matters at all, one wonders where estate tax repeal will fit in the list of tax-change priorities and whether the optics of estate tax repeal by a wealthy President with a wealth-laden cabinet might prove troublesome to a populist electorate.
If There Is Repeal, What Will Be Its Effective Date?
If Congress passes estate tax repeal legislation, would it be effective immediately (or even retroactive to January 1, 2017) or phased in over many years, and would it be permanent or temporary? Permanent estate tax repeal (especially, immediate, permanent repeal) likely would require 60 votes in the Senate to avoid being defeated by filibuster. In contrast, phased-in, temporary estate tax repeal, like the one-year repeal in 2010 following a 10-year phase in, could potentially pass under a budget “reconciliation” approach that would require only 51 votes in the Senate. While a future Congress could make changes in either case, we would guess that an immediate, permanent repeal would not be undone, whereas a temporary or phased-in repeal might be.
If There Is Repeal, How Will Capital Gains Be Treated at Death?
Under current law, when a person dies, the income tax basis of each of the decedent’s assets gets adjusted (“stepped up”) to its date-of-death value. Under the temporary repeal in 2010, step-up in basis of inherited assets was temporarily replaced by carryover of the decedent’s pre-death basis to the heirs (after step-up of an exempt amount of unrealized gain). President-Elect Trump’s plan during the campaign appeared either to bring back carryover basis or to take another approach – immediate gain recognition at death (after step-up of an exempt amount of unrealized gain) – whereas the House Republican plan, as proposed, would maintain basis step-up on all inherited assets.
If There Is Repeal, Will There Still Be a Gift Tax?
Repeal of the federal estate tax does not necessarily mean repeal of the federal gift tax, and the federal gift tax might be maintained, as it was in 2010, as a back-stop to avoid unlimited transfers designed solely to move assets to individuals in a lower income tax bracket. In contrast, when the federal estate tax was repealed in 2010, the federal generation-skipping transfer (“GST”) tax was also repealed for that one year, and we would anticipate that any new federal estate tax repeal likely would be accompanied by repeal of the federal GST tax.
What Will Happen with Proposed Valuation Discount Regulations?
Earlier this year, the Treasury Department proposed regulations on Internal Revenue Code Section 2704 that could significantly curtail the use of valuation discounts for gift and estate tax purposes. Those proposed regulations have generated significant questions and criticism and have not been finalized. Some commentators anticipate that, after the change in administrations, the regulations will proceed but very slowly. Others (and we tend to agree with this latter group) anticipate that, after the change in administrations, the proposed regulations will effectively be placed on a shelf never to be seen again.
Will Possible Federal Repeal Accelerate State Estate Tax Relief?
In addition to a federal estate tax, many states, including Illinois, have separate state estate taxes. Over the last 15 years, several states, most recently New Jersey, have repealed their state estate tax, while others, including New York and Illinois, have significantly raised the amount of assets that are exempt from state estate tax. Repeal of the federal estate tax might place added political pressure for repeal on states with separate state estate taxes.
As the legislative process unfolds in 2017, we will continue to advise our clients to engage in practical, common-sense estate planning, while maintaining flexibility to adjust to any future changes. In most cases, this approach will mean (i) not rushing to consummate transfers of closely-held business interests for estate tax reasons alone, (ii) properly implementing those transfers that have already been made, (iii) continuing with simpler gift-giving strategies (such as annual exclusion and tuition and medical gifts), and (iv) keeping testamentary estate plans current, especially given the continued applicability of the Illinois estate tax and the many non-tax advantages of trusts. If there is major new federal estate tax legislation, we will report back to our clients and share our insights.
In the meantime, we offer you our best wishes for the holiday season.
This update has been prepared for general informational purposes only and should not be construed as legal advice on any specific facts or circumstances.