This report is not intended to be exhaustive or definitive. I will not cite authorities or quote from experts. I will just speak from my own experience as an estate planning attorney for the past 35 years. The following in just my opinion about what the future of the federal estate tax may be under President Elect Trump. It may turn out that none of my predictions below will occur. I am writing this to let you know about this important subject so you can personally monitor and evaluate what may occur.
Background
The federal estate tax has existed for over 90 years. It is a tax on the transfer of wealth from an estate to beneficiaries. The tax is imposed on the estate itself and is paid from the estate along with other administrative costs. The net estate is then distributed to the beneficiaries. My personal opinion is that the most important consideration in estate planning is to carry out a person’s intent of transferring their property to the persons they want to benefit with the least possible costs and difficulty. However, estate taxes need to be addressed if a client has a taxable estate. The government allows an estate a credit before estate taxes are due. Various terms have been used to describe this credit, but I will use the term “exemption amount” because this represents the amount of money that can pass before estate taxes are due. In my career I have seen this federal exemption amount rise from $625,000 to $5.4 Million. With the right estate plan a couple can currently shelter up to $10.8 Million from federal estate taxes Most of these changes have occurred since 2001. Along with a large increase in the exemption amount, the estate tax rates themselves have gone down. There have also been other advantageous tax law changes that have equalized the estate, gift and generation skipping taxes. As a result of these changes, only 4 in 1,000 estates (0.4%) have to file a federal estate tax return. The bottom line is that most people no longer have a federal estate tax liability.
Discussions about estate taxes have been a volatile and political. Some call it a “death tax” and that death should not be a taxable event. Others feel that it is a just tax on the wealthy. Despite the volatility of the subject, there have been bi-partisan efforts made to prevent the hardships that have occurred in the past. There have also been efforts made to repeal the federal estate tax. I will discuss one of these repeal proposals in the repeal option section discussed below.
Predictions
I believe that one of the following changes to the estate tax law may occur in a Trump presidency.
Conclusion:
- Maintain the status quo. Since most Americans no longer have a federal estate tax liability, the government may just keep the current exemption amount or increase this amount without repealing the estate tax. They may also pass other laws that are advantageous to the public, or which the government feels make the tax fairer.
- Modify the estate tax law. Although the government could reverse course and lower the exemption amount or take other action so more estate taxes are collected, I don’t think that this would be politically popular and would probably be unconstitutional. They could instead increase the exemption amount coupled with other tax law changes so that there wouldn’t be such a dramatic effect upon the treasury.
- Repeal the estate tax law. Although it initial seems unlikely that the government would repeal the estate tax law, there have been serious proposals to do so. I have read many articles discussing that many politicians, on both sides of the aisle, feel that the estate tax system is difficult and expensive. Difficult because every estate tax return has to be audited and expensive because of the staffing and budget requirements of monitoring and enforcing that law. Therefore there have been bi-partisan proposals to repeal the estate tax in return for a modified tax basis law. This was a political compromise because some politicians did not want to lose the revenue brought in by the estate tax. I will explain briefly how the modified tax basis law would work.
We all have a tax basis on our assets. This is usually what we paid for the asset plus improvement less depreciation. There are two types of tax basis assets 1) carry over basis assets; and 2) step-up tax basis assets. When we gift an asset to someone they receive the asset at our lower tax basis, or our tax basis is carried over to the recipient. If the recipient then sells the asset they pay capital gains tax on the difference between the carry-over tax basis and the sale price. By contrast, for many years when someone received an asset from as estate, they received a step-up in tax basis for inherited assets, or the asset values were “stepped-up” to their value at the date of death. If the recipient then sold the asset soon after receiving it, there was no capital gains tax to pay because the sale price equaled the stepped up tax basis. Of course if the recipient held onto the asset and sold it later, the asset could increase in value resulting in a capital gain tax liability.
The repeal proposals I have read would eliminate the estate tax but would impose a potential capital gains tax on the recipient. The government would change the tax basis law to a modified step-up tax basis law. The estates of married people, and some others, would be allowed to “step-up” the basis on a portion of the assets, but the remaining assets would pass under a carry-over tax basis, which usually results in a lower tax basis potentially resulting in a future capital gains tax for the recipient. Tax experts have reflected on the effect of this modified tax basis law proposal and indicated that such a change would require citizens to identify their tax basis on all of their assets and to complete the required forms to elect the assets upon which they would be allowed to obtain a step-up in tax basis. The literature I have read predicts that the government will be able to collect as much, or more, revenue from the capital gains taxes resulting from the new modified tax basis than under the old estate tax system.
I recently read an online article that President Trump’s transition team was proposing repealing the federal estate tax in return for a modified capital gains tax system. I don’t know if this proposal will be the same as the ones proposed before, or if it stands a chance to pass, but I suggest that you watch this proposal carefully and decide if it would be an improvement to eliminate the estate tax in return for the modified tax basis law described above. When evaluating any proposed changes to the estate tax law, remember that such changes will be contained within a larger overall tax proposal.
Minnesota Estate Tax
Many people are unaware that Minnesota has its own estate tax system. This came about because of changes to the federal law under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Under that law the federal government phased out and repealed the state death tax credit. Under the law before EGTRAA states, such as Minnesota, were called “pick-up states.” Under the prior law you filed a federal estate tax return, and if estate taxes were due, your state automatically got part of that tax equal to the state death tax credit. As you can imagine, states did not like this change and many states, including Minnesota, imposed their own estate tax system. The Minnesota estate tax law also has an exemption amount, like the federal system but at a lower amount. The Minnesota estate tax exemption amount was $1 Million for a number of years but has increased over the past few years so that it is scheduled to be $1.8 Million on January 1, 2017 and $2 Million on January 1, 2018. I don’t know if Minnesota will continue to increase its exemption amount after 2018. While the Minnesota estate tax percentages are lower than the federal estate tax rates, it is not an insignificant tax, so you should plan to reduce or eliminate your Minnesota estate tax liability.
Conclusion:
If your current estate is subject to either federal or Minnesota estate taxation, you should take action now to reduce or eliminate this tax liability so your estate is not reduced by this tax liability resulting is less money going to your beneficiaries. You should not wait to see what the federal or state government will do about estate taxation in the future. The current estate tax exemption amount is the best that it has been in decades. However, the government doesn’t just give these benefits to you. You need to have the right estate plan crafted for you so that you take maximum advantage of these tax reduction techniques. Even if you don’t think you have a taxable estate, you should take the time to list all of your assets, including life insurance and retirement plans, which are frequently included in determining the taxable estate. Many people are surprised to find that their estates are taxable. Feel free to contact Estate Planning Solutions if you would like us to assist you.