United States: Obama Proposes "Middle Class" Tax Increases At Death

Last Updated: April 1 2015
Article by Kevin G. Robertson

The prospects of significant tax legislation this year are low. Nevertheless, when the President proposes "tax reform" it makes headlines. The Obama administration's latest tax proposals for fiscal year 2016 would increase dramatically both the rates of transfer/income taxation at death and the number of people subject to those higher taxes in the event of a family member's death.

Since 2011, the lifetime federal estate tax, gift tax, and generation-skipping transfer ("GST") tax exemption equivalents applicable to each individual have been set at $5,000,000, adjusted each year for inflation ($5,430,000 per person in 2015). For the few individuals who make taxable gifts or who have taxable estates in excess of $5,430,000, the federal estate, gift, and GST tax rates have been set at 40%.

As now in effect, far less than 1% of decedents' estates are subject to federal estate tax. Thus, under current law, the vast majority of Americans would be able to transfer to their children or other loved ones whatever wealth they may have left at their death, free of any federal estate tax.

I. Decreasing Estate/Gift/GST Tax Exemptions and Increasing Tax Rates

The Obama administration proposes to decrease estate tax and GST exemption equivalents from the 2015 level of $5,430,000 (adjusted for inflation) to the 2009 level of $3,500,000 (with no inflation adjustments). By not indexing the estate tax and GST tax exemptions for inflation, the effect would be to increase taxes each subsequent year in which inflation "eroded" the value of the unadjusted exemption.

Further, it is proposed that the estate/gift/GST tax rate would be increased from its current 40% level to 45%.

Finally, the administration proposes to decrease the gift tax exemption from the current "unified" level of $5,430,000 to the 2009 level of only $1,000,000 (also with no inflation adjustments). This proposed "disconnection" of the gift tax exemption from the estate/GST tax exemption would have the effect of discouraging lifetime gifts.

For example, if a surviving parent had net assets of $2,500,000 and wished to make lifetime taxable gifts totaling $1,500,000 to his or her children (for instance, to help them buy homes), such gifting would attract a tax of $225,000, 45% of the $500,000 by which the gifted amount exceeds the proposed $1,000,000 gift tax exemption. But if that parent simply held on to his or her net assets and had them pass to his/her children at death, the $2,500,000 (even if the values grew modestly) would pass entirely estate-tax-free, even under the proposed, reduced estate tax exemption equivalent of $3,500,000.

II. Increasing Death Taxation by Imposing a Capital Gains Tax at Death

Under current law, if someone inherits a capital asset, such as a rental property or a stock portfolio, the inherited property receives an income-tax-basis adjustment so that its "cost basis" for income tax purposes generally is adjusted to be equal to its value on the date of the decedent's death. Such income tax treatment (commonly referred to as the "step-up" in basis, although in some cases it can result in a "step-down") allows the assets of a decedent's estate to be sold without incurring any substantial, built-in capital gains taxes. For example, this becomes quite important if the decedent had any significant debts, since it allows a decedent's assets to be liquidated to pay debts and expenses without being subject to additional income tax.

The Obama administration proposes a general increase in long-term, capital gains tax rates (and tax rates on qualified dividends) from 20% to 24.2%, while retaining the "high-income taxpayer" net investment income surtax of an additional 3.8%, so the top effective tax rate on capital gains would increase to 28%. In addition, all capital assets with built-in appreciation at a decedent's death would be deemed to have been sold immediately prior to the decedent's death for their then-fair-market value.

In effect, the Obama administration is proposing to institute a Canadian-style "deemed income taxation at death" approach. However, unlike Canada, which imposes only an "income tax at death," the Obama administration proposes to impose both the "income tax at death" and an estate tax.

The effective, combined rate of federal "taxation at death" rate on inherited highly appreciated capital assets would be as high as 60.4% for decedents with taxable estates above $3,500,000 who fall into the highest income tax rate brackets: 45% proposed new estate tax rate, plus the 28% proposed new effective capital gains/ investment income tax rate, less the "value" of having the capital gains tax at death treated as a liability payable in connection with the decedent's final income tax return (45% x 28%, an effective reduction of 12.6%).

The only proposed "exclusions" applicable to the new capital gains tax at death would be (i) $100,000 per decedent (portable to a surviving spouse, so $200,000 per couple); (ii) a $250,000 "residence" exclusion (also portable, so a surviving spouse would enjoy an effective $500,000 exclusion); and (iii) the exclusion now available for certain "small business stock." Also, the proposal includes a suggestion that the capital gains tax would not be imposed on a "small" family-owned business until the business was sold or ceased to be owned and operated by the family.

Consider a middle-class retiree (surviving spouse), age 85, who worked and saved for 40 years and managed to accumulate a net worth of $1,000,000 (an $800,000 stock portfolio with built-in gain of $500,000, and a modest $200,000 residence with built-in gain of $150,000).

If the retiree died, leaving the property to his or her children, the new Obama proposals would result in a capital gains tax of at least $96,800 at the survivor's death (24.2% capital gains tax on $400,000 of "net capital gains" after applying the $100,000 "exclusion" to be available). Without any sort of "income averaging" available, the new proposal likely would cause the retiree to be a "high income" taxpayer on his or her final income tax return, since the entire lifetime accumulation of appreciated capital investments all would be "deemed to be sold" and taxed on the decedent's final income tax return.

Finally, consider what happens if the retiree "downsizes" and moves to a small apartment, reinvesting the $200,000 that had been "locked up" in the principal residence. If that amount gets reinvested and grows to $300,000 at the death of the retiree, an additional $24,200 "income tax at death" would be imposed (and more likely a $28,000 "income tax").

The Tax Group of BakerHostetler closely tracks key legislative developments and will be paying close attention to these proposals, as well as any offered by members of the House of Representatives or the Senate, as the public debate regarding fundamental tax reform unfolds.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions