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Q&A: The future of the estate tax
February 1, 2017 at 8:53 AM

Handwritten "Q&A"Q: What do you think about the future of the estate tax now that Trump is president? I heard one of his proposals was to eliminate the estate tax. Do I need to even be concerned with estate tax planning going forward?

A: I understand your concern. President Trump’s tax reform proposal, as described on his campaign website, stated that, “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.”

Q: So is the death tax the same as the estate tax? What about capital gains at death? How will that work?

A: It is probably safe to assume that the death tax in his proposal is referring to the estate tax. With respect to the capital gains tax at death on assets valued over $10 million, it is not as clear. One possibility is that assets valued over $10 million will be treated similar to how assets are taxed in Canada at death. In Canada, there is no estate or inheritance tax. Instead the Canada Revenue Agency treats the decedent’s estate as though the decedent disposed of all their assets immediately before death, in a taxable transaction like a sale. Thus, gain is recognized to the extent the value of the assets exceed their basis, unless the estate is subject to an exception such as being inherited by the surviving spouse or common-law partner. Therefore, it’s possible under Trump’s plan unrealized gains would be recognized at death, but only on assets exceeding a $10 million threshold.

However, another take on this is that instead of gains being recognized at death, the appreciated property in excess of $10 million will be subject to a carryover basis, subjecting beneficiaries to income tax on the gains when they dispose of the property in the future. Recall that when the estate tax was repealed for 2010, carryover basis took effect (i.e., no basis step-up). It is not clear, though, that carryover basis will be enacted if the estate tax is repealed. Some say it will be a question of cost.

Q: Trump also mentions in his proposal that he will disallow certain contributions to a private charity established by the decedent or the decedent’s relatives. What is this about?

A: That’s right. Under Trump’s plan, “contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives will be disallowed.” Unfortunately, it is unclear what “disallowed” means and whether this disallowance will apply only at death, or if it will also apply to lifetime transfers.

Q: Trump’s plan doesn’t mention anything about the gift tax? Will that also be repealed?

A: There is no mention of repeal of the gift tax in Trump’s proposal. Similarly, in the House Republican Blueprint, there is no mention of repeal of the gift tax.

Many commentators point out that the gift tax works as a “back stop” to the income tax. As an example, if the gift tax were repealed, a parent could gift an asset to a child in order to shift income to a child who is in a lower tax bracket. After the transfer, which will have no cost, the child could sell the asset, recognize a lower income tax than the parent and then gift a portion or all of the sale proceeds back to the parent. This is just one example of why a repeal of the gift tax could cause a significant reduction in government revenue from income tax receipts. As a result, many believe repeal of the gift tax is unlikely.

Q: You mention the House Republican “blueprint.” What is that?

A: In June 2016, House Republicans released a “blueprint” for tax reform. The blueprint generally makes a proposal to reduce tax rates for businesses and individuals. Under the U.S. Constitution, revenue measures must originate in the House. Because Republicans control the House and the Senate, it seems likely that the House will begin the tax reform process by proposing a bill based on the “blueprint,” modified to incorporate parts of the Trump proposal.

Q: In what other ways is the House blueprint similar to Trump’s proposal with respect to estate and gift taxes?

A: The House blueprint similarly proposes to repeal the estate tax. However, it leaves the basis step-up at death. It also seeks to repeal the generation-skipping transfer tax, which is the tax on transfers (like the estate tax) to those two or more generations younger than the transferor. As I mentioned, it doesn’t address the repeal of the gift tax.

Q: So if the House Republicans propose such a bill, and it includes such things as estate tax repeal, what is the likelihood of it being passed?

A: The House Republicans have set forth proposals and, as recently as April 2015, obtained the votes to pass a bill to repeal the estate tax. The 2015 bill, however, kept in place the “basis step-up ” provisions of the tax code. At that time, there were not enough votes in the Senate to pass the bill (60 votes needed), and then-President Obama would have vetoed it anyway. However, six Senate Democrats have voted for estate tax repeal in the past (there are now 52 Republican Senate seats and 46 Democratic seats).

Many commentators appear to concede that a repeal, coupled with a capital gains tax on death, may be able to get the Senate votes required. However, such a bill would need to be part of an overall tax reform effort, requiring a compromise on both sides. What is different now is the willingness on the part of a Trump administration to possibly agree to a loss of basis step-up for income tax purposes. This results in not just a repeal of the estate tax, but would in effect be replacing it with an income tax on inherited assets.  Thus commentators seem to agree that if repeals are of the estate and generation-skipping transfer tax with a carryover basis (i.e. no basis step-up at death), there’s some real potential for traction.

On the other hand, some believe it is likely that at least one or two Senate Republicans will vote no for any tax reform bill, and believe there is little chance a Democrat would vote yes if it included estate tax repeal.

Q: Wouldn’t a filibuster by the Senate Democrats stop any tax reform that includes estate tax repeal?

A: Maybe, but there may also be a way around it. Despite being the minority party in the House and Senate, the Democrats still retain the ability to filibuster legislation, requiring, like I mentioned, a compromise on both sides. However, it is possible the Republicans could ultimately pass tax reform as budget reconciliation legislation, which, under what is called the Byrd rule, would have to sunset after 10 years (recall President George W. Bush’s sunset provision on his 2001 tax reform). Under the Byrd rule, any reconciliation legislation that increases deficits in years beyond the period covered by the budget resolution is subject to a point of order that can only be waived by a three-fifths (60 percent) vote. The budget reconciliation bill will require a 10-year budget, hence the 10-year sunset.

You should also keep in mind that while tax reform is a priority for the Trump administration, it is second to health reform. It will likely only be after that health reform issue is resolved that tax reform will proceed.

Q: So with all this uncertainty, how do you plan?

A: Let’s save that for our next conversation.

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