Two bills introduced in Congress in January 2017 called for elimination of the federal estate tax. One was introduced by a Republican Representative from South Dakota and another was introduced by a Republican Representative from Texas. Both bills were introduced to the House Ways and Means Committee, and that is all the action that has been taken to date.
Now, President Trump’s “Unified Framework for Fixing Our Broken Tax Code” includes a provision that would eliminate the federal estate tax and the generation-skipping transfer tax. The framework is positioned as a blueprint for legislation once the Senate passes a federal budget bill, expected in the next few weeks.
Let’s get back to these two representatives from Texas and South Dakota. One of the elements of the current federal estate tax is that it doesn’t distinguish between liquid and nonliquid assets. Individuals with large tracts of land, a.k.a. farmers and ranchers, more easily have estates valued beyond $5.49 million. Planning for a current maximum federal estate tax rate of 40 percent has been complex for such families who have made their living on the land.
However, according to a recent interview with Warren Buffet, such instances are rare. That’s because only .2 % of Americans (roughly 1 in 500 estates) end up paying any estate tax. Family businesses and farms are allowed to pay their estate taxes over many years. For example, an operating family farm has 15 years to pay off any tax liabilities, according to Nonprofit Quarterly. The majority of these Americans are not farmers or ranchers or very often small business owners, but most often people like Buffet.
Repeal proponents argue that the estate tax is a form of double taxation, in that individuals pay tax on their incomes and businesses throughout their lives, and therefore shouldn’t be taxed again at death. However, a study by the Federal Reserve Board in 2013 found that 55 percent of assets had not been previously taxed at the time of death. Estate tax supporters claim it “equalizes” taxation for those estates that hadn’t been taxed or were “undertaxed” during life through loopholes and capital gains laws.
What isn’t talked about very often, according to columnist Allan Sloan of the Washington Post, is that the current federal tax structure for estates of less than $5.49 million ($11 million for married couples) provides some helpful tax advantages for 99 percent of Americans. Heirs who sell their parents’ home or inherit some stock in a taxable account will not have to pay capital gains tax. They get a “tax-free step-up” in the value of those assets, meaning they don’t have to figure out the original tax basis of the holdings — which would cost more money in probate.
It’s hard to argue that the current top statutory federal estate tax rate (40%) is high, not to mention that some estates are also taxed at the state level. The average rate is 17 percent. Rather than fight to repeal the estate tax, perhaps it’s a better move to reduce the tax rate over time. A gradual shift will maintain a level of public finance support and also maintain a stable approach to charitable giving.
History has shown that higher marginal tax rates as well as any upward adjustment in the federal estate tax exemption has negatively impacted giving. People give to charitable causes for many reasons beyond a tax benefit. However, it seems that the more freedom most people have to keep their money and not worry about taxes, the less they give.
The real issue here is whether the proposed estate tax repeal will also mean that the “step-up” of the basis of assets as of the date of death will go away. The Trump tax proposal does not address that issue. It also notable that the tax proposal does not address whether the gift tax (which is tied in to the estate tax now) is also up for repeal. Stay tuned to our firm’s updates for more information this subject.
Have questions about your estate planning in this tax year or next? Talk to the tax team at LvHJ. We can simplify this complex issue for your personal tax situation.