The proposed tax reform plans of Congress and President Trump call for a repeal of the Federal Gift Tax, Estate Tax, and Generation Skipping Transfer Tax, but not all of these proposals are necessarily calling for the same laws to be repealed.
House and Senate Republicans.
A tax publication released by House Republicans on June 24, 2016, states that their tax reform plan “will eliminate the estate tax and the generation-skipping transfer tax, so that the death of a family member or loved one no longer will be a taxable event.” The 2016 publication also states a desire to address the impact of these taxes “on small businesses and family farms,” but makes no mention of any desired changes to the existing Gift Tax. The following is a summary of the Bills that have been introduced in the House of Representatives and Senate that seek repeal of the Estate Tax and other wealth transfer taxes:
House of Representatives Bill 198 (“H.R. 198”). On January 3, 2017, House Republican, Mac Thornberry, introduced H.R. 198 (the “Death Tax Repeal Act of 2017”). The official title of H.R. 198 is “To repeal the Federal estate and gift taxes.” If passed, H.R. 198 would provide for a total repeal of the Estate Tax, Gift Tax, and Generation-Skipping Transfer Tax, effective for decedents dying, gifts made, and generation-skipping transfers made after the date that H.R. 198 is enacted.
House of Representatives Bill 451 (“H.R.451”). On January 11, 2017, House Republican, Robert E. Latta, introduced H.R.451 (the “Permanently Repeal the Estate Tax Act of 2017”). The official title of H.R.451 is “To amend the Internal Revenue Code of 1986 to repeal the Estate Tax and retain stepped-up basis at death.” If passed, H.R.451 would provide for a total repeal of the Estate Tax, effective for estates of decedents dying after December 31, 2016.
House of Representatives Bill 631 (“H.R.631”) and Senate Bill 205 (“S.205”). On January 24, 2017, House Republican, Kristi L. Noem, introduced H.R.631 and Senator John Thune introduced S.205 (both of which are titled the “Death Tax Repeal Act of 2017”). The official title of both H.R.631 and S.205 is “To amend the Internal Revenue Code of 1986 to repeal the estate and generation-skipping transfer taxes.” If passed, H.R.631 and S.205 would provide for a repeal of the Estate Tax (except for Estate Tax due on distributions from existing Qualified Domestic Trusts for a period of 10 years after the date of enactment of H.R.631 and/or S.205), a total repeal of the Generation Skipping Transfer Tax, reduction of the present maximum Gift Tax rate of 40% down to a maximum rate of 35%, and preservation of the lifetime exemption amount for the Gift Tax. If passed, H.R.631 and S.205 would be effective for estates of decedents dying, generation-skipping transfers made, and gifts made, on or after the date of the enactment of H.R.631 and/or S.205.
While H.R.198 mentions repealing the Gift Tax, H.R.451 makes no mention of any changes to the Gift Tax and H.R.631 and S.205 only seek to reduce the top rate of tax on Gifts from 40% to 35%. Unlike in H.R.198, H.R.631, and S.205, there is no mention of a repeal of the Generation Skipping Transfer Tax in H.R.451. Lastly, unlike the total repeal of the Estate Tax proposed by H.R.198 and H.R.451, both H.R.631 and S.205 provide for the continued application of the Estate Tax to distributions from existing Qualified Domestic Trusts for a period of 10 years after the date of enactment of H.R.631 and/or S.205. However, besides this small exception, both H.R.631 and S.205 also provide for repeal of the Estate Tax.
Before H.R.198, H.R.451, H.R.631, and/or S.205 are passed into law, they must receive a passing vote of the House, passing vote of the Senate, and President Trump’s signature. Given the apparent discrepancies between all of the above Bills, it seems like congressional lawmakers still need to decide exactly what they want their proposed legislation to cover before it can be passed through the House and Senate.
President Donald J. Trump.
President Trump’s tax reform plan differs from the plans proposed by Congress in how it would repeal the current Estate Tax and replace it with a system that imposes a tax on a decedent’s capital gains (similar to the Canadian Death Tax system). During his campaign, Donald Trump’s campaign website provided the following explanation of his tax reform plan as it relates to the repeal of the Federal Estate Tax: “The Trump Plan will 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 a private charity established by the decedent or the decedent’s relatives will be disallowed.”
On February 9, 2017, President Trump announced that he will make a "phenomenal" tax announcement a few weeks thereafter. After Congress failed to pass legislation concerning repeal of the Affordable Care Act (“ACA”) by President Trump’s deadline of March 24, 2017, President Trump said that he was ready to move on to other legislative goals for 2017, including tax reform. Since then, on April 26, 2017, White House officials released an outline of President Donald Trump's tax plan stating that it would get rid of the estate tax, otherwise known as the "death tax,” which White House officials said would help privately held businesses and American farmers, and on May 4, 2017, the House of Representatives passed a bill seeking to reform the ACA.
The process of passing tax reform in 2017.
If there is a repeal of the Estate Tax in 2017, some experts believe that it will be similar to the kind of Estate Tax repeal that was passed into law under the administration of President George W. Bush. Such repeal would be part of a broader agenda, including reforms of the income tax and corporate tax laws, and could eventually expire, whereupon any repealed wealth transfer taxes would be reenacted into law.
Even if any changes are eventually made to the current system of Federal wealth transfer taxes, House and Senate deliberation and voting on such matters will likely not take place until later this year (perhaps not until around August or later). On January 26, 2017, Speaker of the House, Paul Ryan, mentioned that tax reform will be part of Congress’ spring budget process, with negotiations and deliberations that could last through the summer, perhaps for months before any final action is taken. Paul Ryan also mentioned that one reason for Congress’ delay in dealing with tax reform is that a repeal of the ACA must happen first. As we have seen in the past few months and weeks, completed Congressional action on the ACA may take much more time for Congress to achieve than many republicans were hoping.
Since reform of the ACA was not able to be accomplished as quickly as the Trump administration may have hoped, the White House is now eager for Congress to pass tax reform legislation before its August recess. However, unlike the high expectations of expedience it had set for reform of the ACA, so far the White House seems to be more open to doing what is necessary to pass tax reform, even if it means getting it done after the August recess.
California’s proposed legislation in the event of Federal Estate Tax repeal.
On February 21, 2017, California State Senator, Scott Wiener, proposed that, if the Federal Estate Tax is repealed, California voters should be given the opportunity to approve a California State Estate Tax that would stand in the place of the existing Federal Estate Tax. In 2015, the Federal Estate Tax generated $4.5 billion in Federal revenue from California taxpayers alone. If this revenue solely benefited California instead of the Federal government, it could result in an approximate increase in State revenue of up to 4%.
Scott Wiener’s proposal would require a vote by Californians in order to be passed into law. One might ask why California voters would approve a California State Estate Tax, but in light of the small percentage of the population that such a tax would effect and the generally liberal sentiments of most California voters, it is easier to see how such a tax could realistically be enacted in California, especially in light of the boost in State revenue that could result from the tax.
An unknown fate for the step-up in basis upon death.
If any action is taken by Congress to repeal the Estate Tax, one of the foremost questions is whether such repeal would include any change to the current step-up in basis rules for transfers of appreciated assets upon the death of a decedent.
Generally, a property owner’s basis in an asset is equal to the price the owner originally paid to acquire the asset. If the owner of an appreciated asset decides to sell it during the owner’s life, the owner would need to pay capital gains tax on the appreciated value of the asset.
If the owner of the asset gifted it to another person during the owner’s life, then the recipient of the gift would have the same basis and would likewise need to pay the capital gains on the appreciated value of the asset if the recipient ever sold it after receiving the gift. This is known as “carryover basis” – where the recipient of a gift simply adopts the original owner’s basis in an asset.
If, however, the owner of the appreciated asset leaves it to another person upon the owner’s death, then under current tax law, the recipient’s basis in the appreciated asset would be adjusted to the asset’s fair market value on the date of the owner’s death – this is known as a “step-up” in basis. With a step-up in basis, the recipient of an inherited asset could subsequently sell the asset with little or no capital gains tax liability resulting from the sale.
As described above, H.R.451 seeks to “retain stepped-up basis at death” whereas President Trump’s tax reform plan provides that “capital gains held until death and valued over $10 million will be subject to tax.” The other Bills discussed above make no mention of changing the step-up in basis laws. Assuming President Trump’s outlined tax plan is adopted by Congress and passed into law, at present Federal tax rates, the beneficiaries of a decedent’s appreciated assets may owe capital gains tax at a maximum Federal rate of 20% on the amount of the decedent’s gain that exceeds $10 million. However, it is unclear to what extent, if any, President Trump’s outlined tax reform plan would seek to preserve the step-up in basis for the amount of a decedent’s gain that does not exceed $10 million, or if such $10 million threshold would apply only under specific circumstances.
It is also uncertain whether President Trump’s outlined tax reform plan would require a decedent’s estate to pay the capital gains death tax upon the death of the decedent, or if it would, instead, require the beneficiary of a decedent’s estate to receive a carryover basis in the inherited appreciated assets and thus require the beneficiary to pay the capital gains tax only after subsequently selling those inherited assets. Despite this uncertainty, President Trump’s plan, to the present extent that it has been explained by his administration, appears to have the goal of getting rid of the step-up in basis for certain amounts of inherited appreciated property.
It is worth noting, as mentioned above, that stock and real estate holdings accounted for more than half of the total assets of all decedents whose estates paid Estate Tax in 2015. These sorts of property holdings tend to be responsible for generating large amounts of capital gains for their owners. Thus, President Trump’s proposed repeal and replacement of the death tax, if passed into law, may benefit some wealthy estates whose highly appreciated real estate or stock holdings would be subject to the maximum Federal capital gains tax rate of 20% as opposed to the maximum Estate Tax rate of 40% (assuming, for California residents, that California voters do not subsequently pass a California State Estate Tax that re-imposes the 40% rate). However, certain estates comprised of highly appreciated assets might benefit more from a repeal of the Estate Tax that retains the step-up in basis at death.
Concluding remarks.
If any action is taken by Congress and President Trump to repeal the Estate Tax, it remains unclear whether such repeal would be retroactive to the beginning of 2017 or apply only on or after the date that such repeal is enacted. For now, there is not much that can be done to address any estate planning concerns regarding the possible repeal of certain wealth transfer taxes. Besides, even if there is repeal at the Federal level, California may act promptly to replace the repealed federal tax laws with similar taxes of its own.
Regardless of whether or not any changes are made to the tax laws affecting transfers of wealth, estate planning for non-tax reasons will continue to be an important consideration for the vast majority of Americans. Some important non-tax considerations that are common motivators of estate panning include, without limitation, the following:
◊ Avoiding Probate ◊ Reducing the risk of heirs wasting the estate on huge estate litigation fees ◊ Maintaining the privacy of one’s affairs after death ◊ Providing for the special needs of certain loved ones ◊ Directing who you want to receive your property and how you want them to receive it (i.e., outright, for life, or at certain ages) ◊ Ensuring that certain people inherit particular items of your tangible personal property ◊ Making charitable donations upon death ◊ Preventing a spouse’s share of the estate from being diverted away from his or her children by the surviving spouse’s remarriage ◊ Nominating the legal guardians of your minor children ◊ Selecting who you trust with the management of your financial affairs and personal care needs in the event that your are unable to manage those things for yourself.