Planning and the Death of the Death Tax

May 1, 2017

Authored by: Andrew Bleyer and Larry Brody

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On Wednesday afternoon the White House again proposed eliminating the so-called death tax as part of its tax reform plan, but the details remain sparse.  When pressed for specifics Director Cohn simply stated that with the implementation of the administration’s tax plan, the death tax would disappear.

The phrase “death tax” entered the popular lexicon by way of tax reformers wanting to summarize and caricature the several parts of the Federal transfer tax system.

What is the Death Tax?

The death tax could refer to the estate tax alone or to any combination of other taxes that grew out of the estate tax regime.  The modern estate tax was introduced in 1916.  In its current form it imposes a top rate of 40% on transfers above $5,490,000 per person made at death.

After the estate tax was instituted, savvy taxpayers quickly realized that a deathbed gift would avoid the estate tax altogether.  To prevent this, Congress passed the gift tax in 1936.  The current gift tax has the same top rate as the estate tax and shares the $5,490,000 exemption.  This means any gifts that use gift tax exemption during life reduce the available estate tax exemption at death.  The gift tax also excludes gifts up to $14,000 per year to any one person.

Under the estate tax, if a taxpayer pays estate tax and leaves the entire estate to his or her children, the children would again pay estate tax when the estate is passed to the taxpayer’s grandchildren. To avoid this problem, wealthy taxpayers began leaving a large portion of their estate to their grandchildren (or to trusts for their children for life, then to grandchildren), effectively leapfrogging one generation of the estate tax.  Not to be outmaneuvered, Congress passed the generation-skipping transfer (“GST”) tax on transfers to or for anyone in a generation below the taxpayer’s children.  The current GST tax has the same top rate and exemption level as the estate tax.

To avoid double taxation, Congress also introduced stepped-up basis at death.  This provision resets the basis of property acquired from a decedent to the date of death fair market value.  Thus heirs will not pay capital gains tax on later sales of property that already may have been subject to the estate tax.  Any or all of these tax regimes may (or may not) be targeted by the administration’s planned repeal.  But it is unclear what the tax landscape will look like once the dust settles.

What exactly will be repealed?

It is certain that the White House repeal will target the federal estate tax.  But this may not mean the end of the estate tax altogether, because some states have their own estate or inheritance taxes.  New Jersey may reinstate its previously repealed estate tax regime and California has proposed a new state estate tax based on the existing Federal system, in response to a Federal repeal.  Other states may follow suit.

If the estate tax is repealed it is unclear what will happen to the gift tax.  It could be repealed with the estate tax or retained – as it was under the Bush tax cuts.  Some argue that even if the estate tax is repealed the gift tax is necessary as a backstop against capital gains shifting.  But, if the income tax rates are collapsed, and depending on the capital gains rate, there might not be much need for such a backstop.

The White House plan does not mention what will become of the GST tax.  The House Republican Blueprint eliminates the GST tax.  And indeed it would seem obvious that a GST tax is unnecessary without an estate tax.  But repeal could create a problem if taxpayers unwind all of their GST tax exempt trusts only for the GST tax regime to be reinstated sometime in the future.  For exactly this reason, the GST tax regime was maintained under the Bush tax cuts with a 0% rate for 2010.

It also is unclear whether estate tax repeal would eliminate the rationale for providing a stepped-up basis at death.  At one point the administration thought so.  According to the administration’s 2016 proposal, the estate tax repeal would be accompanied by a repeal of stepped-up basis.  Instead the administration proposed a tax on capital gains at death at a rate of 20% with a Ten Million Dollar exemption.  This tax has not been mentioned in the most recent proposal and it is unclear whether it is still on the table.

The longevity of the death tax repeal may well depend upon the method used to move the tax bill through Congress.  Senate rules dictate that any legislation which increases the budget deficit beyond ten years requires the vote of 60 Senators.  Because the Republicans hold only 52 seats in the Senate, such legislation would require negotiation with the Democrats.  If the Republicans can’t attract votes from Democrats, they can pass their own version of the tax plan but the changes must be revenue neutral or they will sunset after ten years.

Until the details of the death tax repeal are made public and a final bill is passed, it would seem premature to plan for any specific scenario.