Most clients have seen press reports about current tax proposals in Congress that promise significant changes to the taxation of individuals and businesses. H.R. 1, titled the “Tax Cuts and Jobs Act,” was introduced to Congress on November 2nd and is in the early stages of its legislative journey through the House of Representatives and the Senate. Prospects for the adoption of all, some or any of its current components is unclear at this point.
One of the elements of H.R. 1 in its current form is a future repeal of the Federal estate tax. Specifically, the following changes would be made to the estate and gift tax system in the U.S. as it currently stands:
• Beginning January 1, 2018, the amount which an individual would be permitted to transfer free of Federal estate or gift tax would double from $5.6MM per taxpayer to $11.2MM per taxpayer.
• The Federal estate tax would be repealed for persons dying on or after January 1, 2024 --- a
little more than 6 years hence. The Federal generation-skipping transfer (GST) tax would also be
repealed for transfers on or after 1/1/2024.
• The Federal gift tax would not be repealed, but the top marginal rate would be reduced from the current rate of 40% to 35%.
• Assets received from a decedent at death would continue to receive a “step-up” in basis, wiping out pre-death capital gains.
If in reading the last paragraph you get a feeling of déjà vu, you can’t be blamed. We have been here before. In 2001 Congress passed the “Economic Growth and Tax Relief Reconciliation Act” (EGTRRA), which similarly increased the estate tax exclusions and repealed the estate tax at a later date (in 2010). Between 2001 and 2009 the estate tax exclusion soared from $675,000 (the amount in 2001) to $3.5MM (the amount in 2009). And for estates of persons dying in 2010 (such as George Steinbrenner) there was a 0% estate tax. Estate tax had effectively been repealed!
However, the joy of wealthy Americans in getting rid of the Federal estate tax was short- lived. Under the “Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010,” which became law on December 17, 2010, estate tax returned in 2011 and has been with us ever since.
What Would the Proposed Legislation Mean for Wealthy Clients If Enacted?
As a planning practitioner who worked with clients through the period leading up to 2010 flirtation with repealing the estate tax, I have some thoughts on what the current repeal proposal --- if enacted --- would mean for clients’ planning. As I speak to other estate planning practitioners and clients around the country, I think there is actually some level of agreement on these main points:
Don’t bet on there being no estate tax in effect at the time of your death: We have had an estate tax in effect in the U.S. since 1916 --- prior to the entry of the U.S. into WWI. An archaeologically- minded colleague recently pointed out that estate taxes actually go back to the time of the ancient Egyptians. Even if H.R.1 is adopted and a client lives to see the repeal of the estate tax in 2024 with no changes in the law in the intervening years, there is no guarantee that estate tax will stay repealed in the future.
Although estate tax repeal may be illusory, a substantial increase in the gift tax credit would be real: As currently proposed, H.R.1 would immediately double the amount of the gift tax credit, from $5.6MM per taxpayer in 2018 to $11.2MM. A married couple would be able to transfer $22.4MM free of the Federal gift tax. In the period from 2001 to now, as these exclusions have increased, wealthy clients have taken advantage of them by making gifts to “lock in” the use of the exclusions. If H.R.1 is enacted and the exclusion is dramatically increased once more, expect to see a new rush by wealthy families to make more large gifts to family members and long-term trusts.
Flexible, long-term trusts will become even more important in the planning of wealthy families: Over the last decade, as estate and gift tax credits soared, wealthy families have poured assets into long-term ‘dynasty’ trusts that are structured to shelter wealth from taxes and liabilities for successive generations in a family. These long-term trust have often become the “family banks” that finance business endeavors and hold growth investments in a family. If another dramatic increase occurs in the gift tax credit, expect these long-term trusts to gather even more wealth inmthe years to come.
States that impose estate or inheritance taxes may have a harder time retaining wealthy residents:
Nineteen states in the U.S. currently impose either an estate or an inheritance tax on their residents, with top rates reaching 20% in some jurisdictions. If the Federal estate tax is repealed, it may become even harder for these states to keep wealthy residents from migrating to other states where estate taxes can be avoided entirely.
Of course, proposed legislation is just that --- proposed --- and no one is well-advised to make plans based on laws that may or may or may not take effect. We will watch with interest to see how this turns out.
---- Paul McGloin