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.
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. However, death is not a recognition event for income taxes. For instance, if a piece of real estate is purchased for $100,000 and is worth $500,000 when the decedent dies, the $400,000 of gain is not taxed. Under § 1014, the basis of a decedent’s assets are generally adjusted at death to the fair market value of the assets on the date of death, which means that the real property in the above example could be sold for $500,000 by the decedent’s beneficiaries without recognizing gain .
The stated goals of President Obama’s proposed changes to the tax treatment of assets at death are two-fold:
- “Close the Trust Fund Loophole;” and
- Raise the top capital gains and dividend rate.
First, it should be noted that goal 1 is a bit of a misnomer. The “loophole” the President refers to is simply a function of the express rules provided in §1014 and does not have much, if anything, to do with trusts. 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 § 1014. Under the President’s plan, death would be treated as a recognition event, in that there would be an income tax 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, which also treats death as a recognition event. For married couples, there would not be a tax imposed until the second death.
The President’s proposal would allow the transfer of some untaxed gain from one generation to the next, for couples $200,000, and $100,000 per individual. This exemption would be portable between spouses. In the present 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). Again, this exemption would be portable between spouses.
Under the proposal, basic personal property is exempt from the tax. However, collectibles, such as art, would not be. Further, the President’s stated proposal claims to protect the interests of small business owners by providing that no tax would be due on inherited, small family-owned and operated business, 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.
It is unclear from the limited details released so far whether or not the President’s proposed taxation of appreciated assets at death would be in lieu of, or in conjunction with, the current transfer tax system. For instance, Canada abolished its estate tax system in favor of a system that taxes unrecognized gain at death, but some jurisdictions implement both regimes. Most commentators believe that the President will face a tremendous uphill battle in implementing his proposed changes. Nonetheless, after two complete years of relative calm for the estate and gift tax, the proposed changes could put the certainty of the current structure in limbo again.