United States: Preparing Your Estate Plan For Tax Reform

On April 25, 2017, the White House announced its plan for tax reform, in an outline called "2017 Tax Reform for Economic Growth and American Jobs" (the White House Plan). During the campaign, President Trump's tax proposal included a repeal of the so-called "death tax," to be replaced with a tax on capital gains held at death. Notably, the White House Plan now simply proposes to "[r]epeal the 'death tax.'"

In addition to President Trump's plan, Speaker Paul Ryan also proposed a tax plan entitled "A Better Way: Our Vision for a Confident America" (the Ryan Plan), which includes an estate tax and generation-skipping transfer tax repeal. A repeal of the gift tax is not included in either of President Trump's proposals or in Speaker Ryan's plan. Each proposal is preliminary and leaves open questions and opportunities for taxpayers and planners.

Current System

The "death tax" is often used to refer to three interconnected taxes - the estate tax, the gift tax and the generation-skipping transfer tax. Gifts and transfers at death also impact the income taxation of assets. To understand the impact the current proposals will have on the death tax and taxpayers, it is helpful to review the current system.

Gift and Estate Taxes

Currently, every individual has a $5.49 million exemption from gift and estate taxation. Furthermore, this amount is indexed to inflation. Lifetime and testamentary transfers in excess of this exemption amount are subject to tax at a 40% rate. If an individual is married and does not use his or her lifetime exemption, the American Taxpayer Relief Act of 2012 permits the exemption to be "ported" to his or her spouse. Essentially, in 2017, each couple may transfer $10.98 million in assets before being subject to the gift and estate tax. In addition to the lifetime estate and gift tax exemption, each individual has an annual gift tax exclusion, under which he or she may give up to $14,000 (or $28,000 for a married individual and indexed for inflation) to a recipient each year, with no limit on the number of recipients.

Generation-Skipping Transfer Tax

In addition to the gift and estate taxes, the generation-skipping transfer tax is imposed on transfers to individuals two or more generations below the donor. If an individual transfers assets to a grandchild or more remote descendant, the generation-skipping transfer tax replicates the taxation of the asset as if it had first passed to the child's parent and then to the grandchild. Each individual has a $5.49 million exemption from generation-skipping transfer tax, although this exemption is not portable between spouses. Transfers subject to the generation-skipping transfer tax in excess of one's exemption amount are subject to tax at a 40% rate.

Income Tax

Under current law, when an asset is gifted during a donor's lifetime, the recipient steps into the shoes of the donor and inherits the donor's basis in the asset (often referred to as "carry over basis"). No tax is due until the asset is exchanged for valuable consideration, providing for the deferral of any gain recognition.

Appreciated assets held by the decedent at the decedent's death enjoy a basis adjustment, known as a "step-up," to the asset's fair market value at the decedent's date of death.1 The gains accrued during the decedent's life are never subject to capital gains.

Trump Campaign Tax Proposal and Possible Implementations

The Trump campaign plan to reform the estate and gift tax system, released on September 15, 2016, is brief. The plan states:

"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."

Unfortunately, the White House Plan provides no further guidance and does not specify if the repeal of the "death tax" includes repeal of the gift tax, estate tax and generation-skipping transfer tax. But the campaign proposal appears to contemplate repeal of the stepped-up basis regime.

Ryan Tax Plan

The Ryan Plan proposes the repeal of the estate and generation-skipping transfer taxes, but does not address the gift tax or the step up in basis. The proposal states, "[t]his Blueprint also 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."

2017 Tax Reform for Economic Growth and American Jobs

The White House Plan simply includes "[r]epeal the death tax." The outline does not refer to recognition of capital gains at death or the imposition of carryover basis. The outline does not specify if a repeal of the "death tax" includes a repeal of the gift tax or the generation-skipping transfer tax.

What Comes Next?

Will the Gift Tax Survive?

Neither the Ryan Plan nor the White House Plan nor the Trump campaign plan considers the transfer tax system in great detail. But all three proposals appear to agree that no transfer tax should be imposed at death. Assuming, for a moment, that a repeal of the estate and generation-skipping transfer taxes continues to gain momentum, a major open question from all of these proposals is whether a gift tax will be retained.

The gift tax was first introduced in 1924 and quickly repealed, but it was reintroduced in 1932 and has been in place ever since. The gift tax serves as backstop to not only the estate tax but also the income tax. The 1932 House Committee Report explained that the purpose of the gift tax was "[t]o assist in the collection of the income and estate taxes and prevent their avoidance through the splitting of estates during the lifetime of a taxpayer." Without the estate tax in place, the gift tax loses a core reason for existence. The gift tax has also been unified with the estate tax since 1976, meaning that the gift tax exemption and estate tax exemption have been tethered to each other. The gift tax exemption is statutorily set in reference to the estate tax exemption. Without the estate tax, lawmakers will need to reach a consensus as to whether to retain the gift tax and, if so, where to set the gift tax exemption.

What About Capital Gains Held at Death?

Under the Trump campaign plan, President Trump proposed taxing the capital gains on appreciated property held by the decedent at death. His proposal included a $10 million exemption, but did not specify if the exemption was per person or per couple. The plan also did not specify if capital gains held at death would be taxed at death or if the tax would be imposed when the asset was sold by a decedent's beneficiaries. Neither the White House Plan nor the Ryan Plan mention the capital gains treatment of assets held at death.

Charitable Giving

The Trump campaign plan limits itemized deductions to $100,000 for individuals and $200,000 for couples. The plan also proposes to "disallow" contributions of appreciated assets to a private family foundation by the decedent or the decedent's relatives, although it is unclear how and when such transfers would be disallowed. Both campaign proposals would limit tax incentives for charitable giving. The White House Plan promises to eliminate certain tax breaks for the "wealthiest taxpayers" but protect the charitable contribution deduction. The White House Plan does not propose a cap for itemized deductions or address the transfer of appreciated assets to private foundations. By proposing to double the standard deduction, however, the plan could limit the number of taxpayers who itemize their deductions and claim the charitable contribution deduction.

Procedural Hurdles

Republicans hold fifty-two seats in the Senate. A sweeping and permanent estate tax overhaul requires sixty votes to overcome procedural hurdles, requiring bipartisan support. This requirement is imposed by the "Byrd Rule" which requires sixty votes for any legislation that significantly increases the federal deficit beyond a ten year term. A repeal of the estate tax could be passed by a bare majority through a budget reconciliation, but such a change would sunset after one or two budget cycles, to avoid a long term impact to the deficit.

While fifty-four percent of Americans support the repeal of the "death tax,"2 corporate tax cuts rather than estate tax repeal are currently featured at the center of the White House Plan. In order to comply with the Byrd Rule, the lost revenue from these corporate tax cuts will need to be balanced out by other revenue or packaged in such a way to ensure bipartisan support. The repeal of the "death tax" is still on the table, but has many hurdles to jump before it becomes reality.

Conclusion

With tax reform on the table, but details scarce, now is a chance to review your estate plan to make sure it contains the flexibility you need to respond to a temporary repeal of the estate tax. It is also a good time to consider using any gift and generation-skipping transfer tax exemption available to you. An estate tax repeal will likely be temporary. If the Democrats come to hold majorities in the House and Senate, the exemption may be lowered. Any assets transferred at the current exemption level will not be impacted by a future change to the exemption level. Finally, with the potential limitation on tax benefits for charitable giving, you may wish to consider accelerating any charitable giving plans, through gifts to favorite charities, or if you are uncertain about how to deploy your charitable dollars, to a donor advised fund. Please reach out to your Arnold & Porter Kaye Scholer attorney with any questions about your current plan and how it might be impacted by the current proposals.

Footnotes

1. Assets that have depreciated in value prior to the decedent's death receive a "step-down" in basis to the asset's fair market value at the decedent's date of death.

2. March 2016 Gallup Poll, available here.

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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