The first part of 2015 has been busy with proposed changes to the current tax law. Many of the proposals if enacted would directly impact and alter the taxation of wealth transfers under current law. The proposed changes include the President’s plan to treat death as a recognition event for income taxes, various modifications to current law as described in the 2016 “Greenbook,” and the passage by the House of a bill to repeal the estate tax. To give context to the proposed changes, the current version of the estate tax imposes an excise tax (at a rate of 40%) on the transfer of assets at death to non-spouse and non-charitable beneficiaries if the value of the decedent’s estate exceeds the applicable exclusion amount.

Proposal to Treat Death as Recognition Event

Prior to the State of the Union address on January 20, 2015, President Obama released the Administration’s proposed changes related to the taxation of property at death. The stated goals of President Obama’s proposed changes to the tax treatment of assets at death are two-fold:

  1. “Close the Trust Fund Loophole;” and
  2. Raise the top capital gains and dividend rate.

Regarding goals 1 and 2, the proposed changes would increase the rate of tax on capital gains and dividends to 28% (note that the top marginal rate for dividends and net capital gains is currently 20% plus 3.8% for the tax on net investment income). The President’s proposal regarding goal 1 deals with the basis adjustment under at death. Generally speaking, under current law, the basis of a deceased person’s assets is generally adjusted at death to the fair market value of the assets on the date of death. Under the President’s plan, death would be treated as if the decedent sold his or her assets moments before death. An income tax would be imposed on the difference between the basis of the decedent’s assets and the fair market value. The President’s proposal is similar to Canada’s system. For married couples, no tax would be imposed until the second death.

The President’s proposal allows some exceptions. Furthermore, some untaxed gain could be transferred from one generation to the next—the exemption for couples would be $200,000 ($100,000 for individuals). In the proposal, this is known as the “basic exemption.” In addition to the basic exemption, couples would have an additional $500,000 exemption for personal residences ($250,000 for an individual).

Under the proposal, basic personal property is exempt from the tax. However, collectibles, such as art, would not be. The plan carves out an exception for small business owners by providing that no tax would be due on inherited, small family-owned and operated businesses, unless or until the business was sold. Further, any closely-held business would have the option to pay any tax from the gain recognized at death over a period of fifteen (15) years.

The President’s proposed taxation of appreciated assets at death would be in addition to the current estate and gift taxes. It is highly unlikely that the President will be able to receive enough support for his proposed change that it will become law.

The “Greenbook”

Each year the Treasury Department releases its General Explanations of the Administration’s Fiscal Year Proposals or the “Greenbook.” The Greenbook provides technical explanations of changes in the tax law that will coincide with the Administration’s Budget proposals.

Overall, the first proposed change would return the Estate, Gift, and GST taxes (collectively “transfer taxes”) to the law as it existed in 2009. The exclusion for the Estate and GST taxes would be $3.5 million, and the exclusion for the Gift tax would be $1 million. The exclusion levels would not be indexed for inflation. The tax rate would be 45%. Currently, the exclusion for the transfer taxes is unified at $5 million, which is indexed for inflation, and the current rate is 40%. In 2015, the exclusion is $5.43 million. The proposed changes would apply to decedents dying after December 31, 2015.

Several of the 2016 Greenbook’s proposed changes to the transfer tax system would impact certain planning techniques to minimize taxes. Additionally, the proposal would change the treatment of Grantor Retained Annuity Trusts (“GRATs”). GRATs, which are authorized by the Internal Revenue Code, allow taxpayers to transfer the appreciation due to rapidly appreciating assets at a minimum gift tax cost. Under current law, there is no minimum term or minimum taxable gift requirement. Thus, if a taxpayer transfers a rapidly appreciating asset to a “zeroed” out GRAT and survives the GRAT term, the appreciation in excess of minimal interest rate assumptions is removed from their estate. The Greenbook proposes to require a minimum ten year term for a GRAT and impose a minimum taxable gift of the lesser of $500,000 or 25% of the value of the assets contributed to the GRAT.

The last significant change the Greenbook proposes to make to the transfer tax system is to modify the current law relating to annual exclusion gifts. Currently, a donor may exclude up to $14,000 per recipient of annual gifts, as long as the recipient has a present interest in the property. The proposal in the Greenbook seeks to abolish the present interest requirement and change from a per donee focus to a maximum of $50,000 of gifts a donor may make in one year, regardless of the number of recipients. Thus, under the proposal, a taxpayer would no longer be permitted to transfer $14,000 to an unlimited number of recipients.

H.R. Bill 1105

In April, the House of Representatives passed H.R. 1105 or the Death Tax Repeal Act of 2015 by a margin of 240 to 179. The version of the bill passed by the House of Representatives would repeal the estate and generation-skipping transfer taxes. If enacted into law, the bill would leave the gift tax in place with certain modifications.

The bill would lower the rate of tax on taxable gifts from 40% to 35%. The basic gift tax exclusion amount would remain at $5,000,000, indexed for inflation, and the annual exclusion would remain at $14,000. The bill would not change the current law regarding a “step-up” in basis at death for assets in a decedent’s estate. Finally, lifetime transfers to trusts that are taxed as “grantor” trusts would not be considered taxable gifts.

Although the House of Representatives has voted to pass H.R. 1105, the bill will not become law until the Senate also passes it and President Obama signs it into law. The White House has been adamant that the President would veto the Death Tax Repeal Act of 2015. The Senate is also considering its own version of the Death Tax Repeal Act of 2015, which is currently before the Senate Finance Committee.

Regulations Under § 2704

Treasury is expected to issue Proposed Regulations under § 2704, which may limit the ability of taxpayers to receive valuation discounts for transfers of family-controlled entities to family members. Currently, when an interest in a family-controlled entity is transferred gratuitously between family members, the value of the interest for transfer tax purposes often reflects valuation discounts. For example, family members often transfer non-voting interests in an LLC to lower generations. The reason for the valuation discount is that a hypothetical buyer would pay less for a non-voting interest in the LLC because of the lack of control and marketability associated with the interest.

The Proposed Regulations under § 2704 are expected to limit the applicability of valuation discounts to intra-family transfers of family-controlled entities. Thus, the tax cost of transferring assets from generation to generation will increase. The Proposed Regulations may be issued prior to the end of the year.

Conclusion

The changes to current law proposed in the first six months of 2015 regarding the taxation of wealth transfer are significant, and if in enacted would certainly result in an increase in both income and transfer taxes. Changes to the existing tax law will likely not occur quickly. It will be a political struggle for either side’s proposals to become law—at least prior to the election in 2016.