This column was originally published in the Grand Rapids Business Journal on September 9, 2016 and is republished with permission.
As some readers may have noticed, we recently had a national election, and as a result on January 20, 2017 the United States will have for the first time in many years a federal government with a single party controlling both the executive and legislative branches. The expectation is that the recent history of gridlock, with the legislative output of congress at historically low levels, is about to change, and that a flood of bills embodying the legislative priorities of the Republican Party will move quickly through congress to be signed, presumably, by President Trump.
High on that list of priorities is repeal of the federal estate, generation skipping, and gift taxes, which for practical purposes have been branded by their policy opponents as the “death taxes”, although a better, if less politically charged, combined term would be “transfer taxes”. All of the targeted taxes are aimed at taxing transfers of wealth, or interests in wealth, and are excise taxes on the actual transfer, rather than on the occurrence of death. Since the last major action by congress in this area in 2013, these taxes have been limited in practical effect to the top 0.2% of taxpayers, because there is a significant amount of wealth required to trigger any tax liability. The combined exemption from the transfer taxes is $5,490,000 per individual effective for the 2017 calendar year. Notwithstanding their limited application to the broad spectrum of society, repeal of the transfer taxes has been a major priority of the Republican Party for at least 20 years. As an aside, many state estate or inheritance taxes have been repealed over that time period as well, including for all practical purposes the Michigan Estate Tax in 2004.
The transfer taxes are often characterized as not being substantial revenue raisers, although some might consider the approximately $17,000,000,000 raised by the taxes during 2015 (from a total number of 4,918 taxable estates) as material. Given the lack of concern about the federal deficit expressed by the incoming administration, however, it appears unlikely that this revenue reduction will be viewed as a substantial impediment to repeal. Similarly, the charitable community and life insurance industry have significant concerns about the impact of repeal on their respective concerns, but while both have significant political clout, they appear to be reluctant to vocally resist the current political winds.
As a result, in the view of your author, it is more likely than not that the current transfer tax system will be repealed. While that prediction can be made with a relatively high degree of confidence, however, there are a number of aspects of how that might occur that will have a substantial impact on how high net worth individuals and their advisors plan for the future. Therefore, it is advisable to give some thought currently as to how the resolution of these issues might play out, and the implications of various possibilities for repeal on certain categories of individuals, businesses, and families.
In particular, for individuals considering closing on transactions during 2016 involving the transfer of interests to family members that will or might be deemed to constitute taxable gifts, serious consideration should be given to delaying closing until the future of the transfer tax system is determined. In that event, it is likely that the repeal would be prospective, such that a transaction might trigger a gift tax liability that could have been avoided by a post-repeal closing date. An individual who incurs gift tax liability on a transaction that closes on December 30, 2016 will not be happy if a similar transaction on January 2, 2017 would not have been subject to any transfer tax. Of course, there may be circumstances that make delay unappealing, but the likely change in potential transfer tax liability should definitely be considered as a material consideration. Transactions that do not risk gift tax exposure, such as annual exclusion gifts ($14,000 per donee for 2016) or a grantor retained annuity trust transfer that takes advantage of relatively low interest rates to shift future appreciation to future generations without constituting a current gift are worthwhile planning under any scenario and should continue as bread and butter approaches for family wealth retention planning.
While much is uncertain, including the length of time that inherited wealth will be able to be passed to future generations without transfer tax following the likely repeal of the current system, one certainty is that repeal will present significant opportunities for wealth transfer and retention. Given the projected levels of future budget deficits, it is not unlikely that a future congress or administration will again view the wealthy as a target for raising revenue. While we can not know the details of a potential successor system in the event that the political winds change, given the complexities involved and the lack of institutional knowledge that a future congress will have on these issues, it is highly likely that a future transfer tax will operate in a fashion similar to that in place pre-repeal. Therefore, taking prompt action during a period in which there is no transfer tax will be exceedingly important, using techniques such as long-term family trusts that are designed to avoid features that would cause their creators and beneficiaries from being subject to future transfer taxes.
Another area of concern is a possible change in the rule relating to the reset of cost basis to date of death value, such that the successors of individuals who die owning appreciated assets will receive those assets, in most cases, without any exposure to capital gains on disposition for pre-death gains. One part of the Trump proposal would limit the application of this basis step up, but only to the extent that the transferred property exceeded $10,000,000 in value and was received by a successor other than a surviving spouse. Given the complexity and administrative difficulties inherent in this proposal, it is not likely to be enacted, but it is yet another area where planning to limit future capital gain exposure will be important once the shape of the revised law takes shape.
Regardless of the detail of the repeal/replace process-that it is critically important for individuals not to file and forget their estate plans. Not only should individuals keep their estate planning documents up to date and consistent with changing personal and family circumstances, they and their advisors must remain cognizant of changes in the tax law and the opportunities afforded to limit future exposure to a reincarnated transfer tax system.