With the upcoming Republican control of the executive and legislative branches, tax changes are certain to occur. As articulated thus far, President-Elect Donald Trump has proposed the elimination of the federal estate tax in favor of a deferred capital gains tax on appreciated assets in excess of $10 million, excluding small businesses and family farms. This plan is likely to have broad support from a Republican Congress.
For 2016, the federal unified credit exempts up to $5.45 million per person from federal estate tax; for 2017, that figure is set to increase to $5.49 million. Under current law, to the extent that the value of the estate exceeds the exemption amount, estate tax is due at death, subject to certain deductions, such as the marital and charitable deductions. Assets held by the deceased receive a basis adjustment for income tax purposes, with the result that unrealized capital gains to date of death are not subject to income tax. Thus, if an asset was purchased by the deceased for $100 and at death the asset is worth $1,000, no capital gains tax is due on the $900 of gain and the estate's basis in the asset would be stepped up to $1,000.
Until recently, the federal estate tax rate has been higher than the top capital gains tax rate – at one time, the differential was a highest marginal rate for estate taxes of 55 percent and a capital gains tax rate of 20 percent for high-income taxpayers. The spread has narrowed to a current federal estate tax rate of 40 percent and an effective capital gains rate of 23.8 percent for high-income taxpayers. The spread is even narrower for high-net-worth individuals in states with high income tax rates, such as California, New Jersey and New York. While the details have not yet been provided regarding how the capital gains tax will work, it does not appear to be an automatic imposition of capital gains tax at death. However, current estate plans may generate capital gains tax at death if assets are required to be sold either by the terms of the estate plan or to provide liquidity for the family. Even if assets are not actually sold, some formula bequests may trigger capital gains tax.
Under the Trump proposal, small businesses and farms are exempt from the $10 million cap on date of death basis adjustment. Note that "small business" has not yet been defined, and there is currently no exception for appreciated assets passing to a private charitable foundation controlled by family members. It is not clear why transfers to private charitable foundations would be treated far less favorably than under current law. Nor is it clear whether the personal representative for the estate may select which assets to exempt as part of the cap, or whether all assets other than small businesses and farms will receive a pro rata adjustment to basis.
While we await the anticipated changes, we recommend consideration of the following:
Holland & Knight's Private Wealth Services Group will continue to monitor all legislative proposals as the discussion continues.
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