A bit of tax history is in order. In 2001 President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 which eliminated what he had dubbed during his campaign the “death tax” … except it wasn’t a real repeal. Under that legislation, after a nine year phase-out of the tax more formerly known as the federal estate tax, because of a rule known as the Byrd Rule the tax was eliminated for just one year, 2010. So if you were lucky enough, say, not only to be a billionaire but also to own the New York Yankees AND die in 2010, your estate would not have been subject to federal estate tax. The repeal of the federal estate tax was “sunset” in 2011 and the tax has been with us since then, albeit with an inflation-adjusted $5,000,000 exemption and an historically meager 40% maximum rate.
Leaping forward to modern times, during his campaign, Donald Trump promised to eliminate the federal estate tax as discussed in an article on Wealth Management. His plan for repealing the tax can be found in https://www.donaldjtrump.com/policies/tax-plan (scroll down to “Death Tax”). Except here again the plan really isn’t to repeal the estate tax but to replace it with what could be thought of as a capital gains tax on death. The tax would only apply to the very wealthy (sometimes called the very very wealthy) in that the first $10,000,000 of capital gains would be exempt. It is not clear whether the tax would apply to assets passing on death to a spouse or charity but presumably it would not. It is also not clear how the tax would apply to qualified retirement accounts and IRAs. The rate of the capital gains tax on death would be 20% (the same as today’s highest long-term capital gains rate).
So let’s say under the Trump Plan an unmarried client owns one stock with an income tax basis of zero and a fair market value of $20,000,000. If that client dies and leaves the stock to her children, there would be $20,000,000 of capital gain, the first $10,000,000 of which would be exempt and the second $10,000,000 of which would be subject to a 20% capital gains tax on death in the amount of $2,000,000. Presumably after the tax is paid the children get the remaining $18,000,000 of stock with a basis of $18,000,000 (although it is difficult to say for sure, with the little guidance we have, if that would be the correct result). If the children actually sell the stock the next day they would have no capital gain.
Under current estate tax law, on the death of our hypothetical client there would be a federal estate tax of $6,000,000 and no capital gains if the children sell the remaining stock (worth $14,000,000) the day after our client dies.
So the Trump Plan saves our client’s children $4,000,000 ($6,000,000 minus $2,000,000).
If you need to review your estate plan – or you don’t have an estate plan – what should you do during this period of uncertainty about the future of the estate tax? No one knows what tax legislation will be presented to Congress and what President Trump will actually sign. For estates which are under the current $5,450,000 exemption (increasing to $5,490,000 in 2017) most likely nothing will change. It is also fair to say with our limited information that for individuals with built-in capital gains of less than $10,000,000 there will be no tax on death under the Trump Plan. For those considering tax-motivated-only gifts to avoid the current federal estate tax, discuss with your advisors holding off (although gifts are more effective the earlier they are made) until we know what the new law will be. For those who would be subject to the capital gains tax on death under the Trump Plan, assuming that the Plan does not include a deemed capital gain for lifetime gifts of low-basis assets, making lifetime gifts which would have reduced the current federal estate tax should also reduce the capital gains on death tax, although the tax-savings would be less. The challenge is structuring the gifts so as not to waste the $10,000,000 exemption under the Trump Plan.