At this time, it is difficult to determine what the specific provisions of President-elect Donald Trump’s tax proposals will be. However, it is important to highlight some of the types of tax planning that are not likely to be affected, and therefore could, and should, continue.
First, in 2016, federal estate and gift taxes became an issue for estates (including life insurance that is not in a Crummey trust) over $5.45 million per individual or $10.9 million per couple. For estates under those amounts, there is not a need to worry about federal estate and gift taxes (except insofar as gift tax reporting may be needed for those gifts over $14,000 to an individual).
Second, basic planning for wills, trusts, medical directives and powers of attorney still need to be done, since the probate process after death isn’t going away. There will still need to be planning for minor children, businesses, out of state property ownership, etc.
Likewise, planning will still need to be done for beneficiary designations, retirement plans and specialized trusts because IRAs/401Ks will continue to be needed for non-spouse beneficiary asset protection purposes, as well as to protect the interest of minors.
Third, there will still be a need for protecting assets, income tax planning and proper reporting (especially for foreign assets). Therefore, a significant amount of planning will not change regardless of the administration.
Estate Taxes Under Trump
According to the donaldjtrump.com website (as of 11/15/16), his policy as to the so-called “death tax” is as follows:
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.
So, for the vast majority of estates, those below $10 million, there will still be the same step up in basis as before.
As an explanation, step up in basis currently works as follows. Consider a scenario in which a decedent bought a rental home for $10, which is worth $100 at the time of the decedent’s death. If the decedent sold it during the decedent’s life, there would have been $90 subject to the capital gains tax.
Under current law at death the basis would be stepped up for the beneficiaries or heirs of the decedent’s estate, so that if they sold it for $100, there would be no capital gains tax. Note that this capital gains tax is separate from the estate tax discussed above, and so the purpose of the step up is to prevent double taxation (i.e., both estate and capital gains tax). Trump’s plan lists a maximum capital gains tax rate of 20 percent.
As shown above under Trump’s plan, for estates over $10 million, there would be no step up in basis for those amounts over $10 million. To use our example above, if the rental property were part of capital gains in excess of $10 million, then there would still be the $90 subject to capital gains tax at death. However, the beneficiaries would not have to pay the estate tax, which is currently at 40 percent for those amounts over the exclusion amount.
There is also the anti-abuse provision set forth in Trump’s plan, regarding prohibitions on transfers of appreciated assets to closely held family charities. Any plans involving such gifts will have to be closely analyzed as we receive more information regarding the plan.
Trump’s plan will likely mean that there will be strong incentives to keep taxable estates within the family, via trusts, to postpone the capital gains tax as long as possible. Therefore, the rule against perpetuities will be very important to consider, and states that have abolished the rule (or have a very long time period) will have many wealthy people taking advantage of their trust laws.
The rule against perpetuities is the most dreaded question on a law school exam, so we won’t go into it here. Suffice to say for our purposes the rule against perpetuities is a limitation on the time period that an interest in a trust can vest.
However, it is possible that the actual estate tax repeal proposal will contain restrictions against dynastic trusts. It is also unknown as to whether or not the gift tax will also be repealed.
We have had just such a carryover basis regime as recently as 2010. As has been noted by several practitioners, Canada also has such a system. The Canada Revenue Agency website describes their treatment of property at death as follows:
When a person dies, we consider that the person has disposed of all capital property right before death. We call this a deemed disposition. Also, right before death, we consider that the person has received the deemed proceeds of disposition (we will refer to this as "deemed proceeds"). Even though there was not an actual sale, there can be a capital gain or, except for depreciable property or personal-use property, a capital loss.
One of the main concerns regarding a carryover basis system like Canada’s is the problem of determining historical basis; this value can be difficult to determine for older property.
Interestingly, and as a possible solution to the historical basis issue in Trump’s plan, when Canada moved away from its estate tax to a capital gains tax system in 1972, it had a “valuation day” to adjust the cost basis of property owned prior to 1972 to be the fair market value as of Dec. 31, 1971 (there are actually special rules for calculating this amount which go beyond the scope of this article). However, it is unclear at this time if such a “valuation day” will be a part of any Trump proposal.
Putting the estate tax into perspective, according to the IRS, the number of estate tax returns declined by 74 percent between 2005 and 2014 due to higher exemption amounts, and the federal estate and gift taxes raised $19.2 billion in revenues in 2015, which is less than one percent of federal revenues. Trump’s plan, as outlined herein, will not completely eliminate this revenue source, but it may, and likely will, reduce it.
In conclusion, the vast majority of estates will be under $10 million, and will therefore see little change. However, proper planning will still be important for beneficiary designations, probate, protecting assets, minor children, out of state property and retirement benefits.
This article was originally published in Law360 and is reprinted with the permission of Law360, ©2016