United States: Potential Transfer Tax Reform And 2016 Year-End Tax Planning Considerations

David Scott Sloan and Shari A. Levitan are Partners and Kevin M. Bergesen is an Associate all in our Boston office .

HIGHLIGHTS:

  • President-Elect Donald Trump has proposed the elimination of the federal estate tax in favor of a deferred capital gains tax on appreciated assets in excess of $10 million. This plan is likely to have broad support from a Republican Congress.
  • Under the Trump proposal, small businesses and farms are exempt from the $10 million cap on date of death basis adjustment.
  • Although income tax rates are likely to decline, deductions may be substantially curtailed, with the result that effective tax rates may not change much for some taxpayers.

With the upcoming Republican control of the executive and legislative branches, tax changes are certain to occur. As articulated thus far, President-Elect Donald Trump has proposed the elimination of the federal estate tax in favor of a deferred capital gains tax on appreciated assets in excess of $10 million, excluding small businesses and family farms. This plan is likely to have broad support from a Republican Congress.

For 2016, the federal unified credit exempts up to $5.45 million per person from federal estate tax; for 2017, that figure is set to increase to $5.49 million. Under current law, to the extent that the value of the estate exceeds the exemption amount, estate tax is due at death, subject to certain deductions, such as the marital and charitable deductions. Assets held by the deceased receive a basis adjustment for income tax purposes, with the result that unrealized capital gains to date of death are not subject to income tax. Thus, if an asset was purchased by the deceased for $100 and at death the asset is worth $1,000, no capital gains tax is due on the $900 of gain and the estate's basis in the asset would be stepped up to $1,000.

Until recently, the federal estate tax rate has been higher than the top capital gains tax rate – at one time, the differential was a highest marginal rate for estate taxes of 55 percent and a capital gains tax rate of 20 percent for high-income taxpayers. The spread has narrowed to a current federal estate tax rate of 40 percent and an effective capital gains rate of 23.8 percent for high-income taxpayers. The spread is even narrower for high-net-worth individuals in states with high income tax rates, such as California, New Jersey and New York. While the details have not yet been provided regarding how the capital gains tax will work, it does not appear to be an automatic imposition of capital gains tax at death. However, current estate plans may generate capital gains tax at death if assets are required to be sold either by the terms of the estate plan or to provide liquidity for the family. Even if assets are not actually sold, some formula bequests may trigger capital gains tax.

Under the Trump proposal, small businesses and farms are exempt from the $10 million cap on date of death basis adjustment. Note that "small business" has not yet been defined, and there is currently no exception for appreciated assets passing to a private charitable foundation controlled by family members. It is not clear why transfers to private charitable foundations would be treated far less favorably than under current law. Nor is it clear whether the personal representative for the estate may select which assets to exempt as part of the cap, or whether all assets other than small businesses and farms will receive a pro rata adjustment to basis.

Year-End Considerations for 2016

While we await the anticipated changes, we recommend consideration of the following:

  1. Revocable Estate Plans: Revocable estate plans should continue to be established in the ordinary course, but with an even greater eye towards flexibility. Existing estate plans containing so-called "credit-shelter trusts" should be reviewed because the funding formula may be tied to the federal estate tax exemption or may be pecuniary in nature, which may result in unintended capital gains taxes at death. Additionally, with the potential for reduced taxes overall, there will likely be greater wealth to be managed appropriately for heirs, making consideration of creditor protection, flexibility for long-term management, and income tax considerations for the trust and for the beneficiaries a priority.
  2. Income and Deductions: As a general rule and to the extent possible, it may be beneficial to accelerate deductions in 2016 and defer income to 2017.
  3. Gifting: Gifts that would generate gift tax should be avoided, unless there is a very good reason to make them, such as an anticipated exponential increase in the value of the asset transferred versus a current modest gift tax. Under current law, the $14,000 annual exclusion remains at that level for 2017, and the aggregate lifetime exemption from taxable gifts for 2016 is $5.45 million and for 2017 is $5.49 million.
  4. Interest rates: Interest rates continue to be quite low, but the Federal Reserve has signaled increasing interest rates in December and some commentators are projecting increased inflation under the Trump Administration. Loans to grantor trusts, outright loans to family members, Grantor Retained Annuity Trusts (GRATs) and sales of assets to grantor trusts continue to be viable estate planning techniques that should be considered sooner rather than later. For married couples, creating an irrevocable gifting trust with the spouse as a beneficiary, i.e., a Spousal Lifetime Access Trust (SLAT), may also provide desirable planning flexibility.
  5. Grantor Trusts: For existing irrevocable trusts that are taxed to the grantor for income tax purposes, grantors should consider whether assets should be substituted into the trust for equivalent value as a way to assure the success of the value transferred.
  6. Charitable Contributions: With income tax rates likely to decrease and certain deductions potentially curtailed, consideration should be given to accelerating charitable contributions of appreciated assets.
  7. Life Insurance: Do not let life insurance policies lapse on the assumption that there will be no estate tax that the policies were intended to address. Depending on the shape of the estate tax legislation, life insurance still may be useful. 

Holland & Knight's Private Wealth Services Group will continue to monitor all legislative proposals as the discussion continues.   

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.

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