2016 Year-end Estate Tax Update: Are Death & Taxes Still a Certainty?
The incoming administration and some Republicans in Congress have indicated they would like to scrap the estate tax, which celebrated its 100th anniversary in 2016. Over the last century, the estate tax has been due on estates ranging anywhere from $50,000 to $5.45 million at rates ranging from 10-77 percent, excluding a temporary reprieve from the tax in 2010.
Current Tax System
The current estate tax exemption is $5.45 million. The limit increases to $5.49 million in 2017. Assets in excess of these limits are taxed at 40 percent. The recent addition of portability rules effectively allows married couples to pass down double the exemption ($10.98 million in 2017) without the use of a credit shelter trust. Statistics show that less than 2 percent of the U.S. population would be subject to the estate tax at the current exemption amount.
In order to prevent taxpayers from circumventing the estate tax, Congress also implemented the gift tax and generation-skipping transfer (“GST”) tax. The gift tax works in conjunction with the estate tax by reducing your estate tax exemption by the amount of gifts made during your lifetime. This way, you can’t give away all your assets while you are alive in an attempt to reduce your taxable estate below the threshold, essentially bypassing the estate tax altogether.
However, there’s a $14,000 annual gift tax exclusion. This exclusion prevents the first $14,000 you give to any person during the year from being counted as a taxable gift and doesn’t reduce your exemption. Other exclusions may allow you to pay another person’s educational and medical costs without reducing your exemption.
The GST tax prevents you from transferring assets to people two or more generations younger than you (i.e., grand-relatives, great-grand-relatives, etc.), which would allow the assets to skip being subject to the estate tax in the interim generation. Such transfers that skip one or more generations are subject to an additional 40 percent tax (when the assets exceed your exclusion).
Congress also allows for a step-up in cost basis and an automatic long-term holding period for inherited assets. This step-up in basis more or less eliminates capital gains tax in the hands of a beneficiary on any appreciation that occurred during a decedent’s lifetime. Unlike the estate tax, the capital gains tax affects a much larger percentage of the U.S. population, kicking in for those in the 25% or higher ordinary income tax brackets as shown below. This step-up does not apply to assets received as a gift. The step-up only happens at death. If you receive a gift from a living person, you generally also receive the basis they had in the asset.
Certain individuals with income in excess of certain thresholds are also subject to the Net Investment Income Tax at a rate of 3.8% on investment income, including capital gains.
The Republicans on the House Committee on Ways and Means published a blueprint for tax reform on June 24, 2016, titled “A Better Way: Our Vision for a Confident America”. Their blueprint proposes to repeal the estate and generation skipping transfer taxes. The Trump administration’s plan for “the death tax,” as published on its campaign website, promises to “… repeal the death tax, but capital gains held until death and valued over $10 million will be subject to tax to exempt small businesses and family farms. To prevent abuse, contributions of appreciated assets into private charity established by the decedent or the decedent’s relatives will be disallowed.”
Neither proposal goes into great detail on how the repeal would be implemented nor if any loss in estate tax revenue would be offset somewhere else. Neither proposal directly mentions eliminating the gift tax, which has served as a back stop to the estate tax. Could it be possible that capital gains will be recognized when a gift is made? Or maybe at death? Will it be a permanent or temporary repeal? Only time will tell.
The timing and the priority of eliminating the estate tax may not be the same as some of the other proposed tax reforms for individuals and businesses. Without a super majority in the Senate, it’s likely that any tax legislation would be pursued through a budget resolution, which occurs once a year and only requires a simple majority of the Senate unless there is a revenue loss beyond the budget window (usually 10 years). Due to the proposed sweeping changes to income taxes, the estate tax repeal, which affects so few, may fall to the wayside as a bargaining chip to accomplish higher priority items. If the estate tax is repealed, it may not be effective in 2017 and could possibly be temporary.
What Should I Do Now?
In most cases, there is no reason to complete any gifts in excess of your lifetime exclusion ($5.45 million) during 2016, because they would require the payment of a tax that may be repealed for 2017. However, smaller gifts under the $14,000 annual per person exclusion can still be made prior to year-end without using any of your lifetime exclusion. Such gifts can be made directly to an individual, to certain trusts, and to Uniform Gifts to Minors Act (“UGMA”) and Uniform Transfers to Minors Act (“UTMA”) accounts. Consider gifting low or no-basis assets to individuals (other than dependent children) who are in the zero capital gains bracket. This allows them to sell the asset without recognizing capital gains, where you may have paid 15-20 percent to sell the asset and give cash.
You can also pay tuition and medical expenses without incurring gift or GST taxes or using your lifetime exclusion. Tuition for elementary school through college is covered under this exclusion. On the medical side, this exclusion would cover braces, medical insurance premiums, and long-term care services. The only caveat is that the payment must be made directly to the educational organization or medical provider.
The Internal Revenue Service (“IRS”) also allows you to front-load a 529 college savings plan with up to five years’ worth of annual exclusions ($70,000 per individual donor or $140,000 if married, to be applied per student). The only caveat is that any gifts you make to the same individual in the following four years will not qualify for the annual exclusion, since it was already used in the initial year. If you are married, consider having only one spouse make this election this year using $70,000 and the other spouse contributing $70,000 in a future year, if you’re unwilling to fully fund the plan now.
Is Estate Planning Still Relevant?
There are still plenty of non-tax reasons for estate planning. Wills and revocable trusts are used every day to ensure that assets are passed down as intended. Revocable and irrevocable trusts also add a layer of privacy to your affairs that a will and probate court do not provide. Trust planning has also increased in popularity as more and more jurisdictions implement Domestic Asset Protection Trust (DAPT) statutes, which may allow you to protect your current assets against future lawsuits, malpractice, or even a divorce. Trusts can also reduce the costs of administering your estate.
Estate planning allows you to control how your assets are used by subsequent generations, ensuring they are productive members of society. Trusts can also be used to preserve government benefits for special needs children.
If you have questions and would like some help navigating the complex world of estate and trust planning, reach out to the professionals with Cherry Bekaert’s Estates & Trusts team. They have a lot of diverse experience in many areas of estate and trust planning, as well as wealth management. They’d be happy to start the conversation with you – and give you some peace of mind.