Presidential Candidate Estate Tax Proposals

by  /  Estate Tax, News, Tax Planning

It is timely to consider Mr. Trump and Secretary Clinton’s proposals regarding estate tax reforms to the “permanent” exemptions [$5 million + inflation] and rates [max of 40%] adopted in 2012. The televised presidential debates have centered on more lurid topics, but proposed tax changes may involve significant sums of money and are worthy of note.

Hillary Clinton

  • Restore 2009 estate tax exemption of $3.5 million.
  • Progressive estate tax rates on taxable estates:
    • 45% up to $10 million
    • 50% over $10 million
    • 55% over $50 million
    • 65% 0ver $500 million
  • Close the “step-up in basis loophole” that increases basis of appreciated assets to date of death value, avoiding accumulated capital gains taxes for the beneficiaries of the bequeath.
    • Treat bequests as “realization events,” forcing immediate income taxation of any built-in gains.
    • Exemptions are proposed to limit application of the new rule to only high-income families and to protect small and closely-held businesses, farms, homes, personal property and family heirlooms.
  • This could result in a top marginal transfer tax rate of 80%, the world’s highest:
    • 65% estate tax rate, plus
    • 4% income tax [39.6% marginal tax rate + 3.8% net investment income tax + 4% surtax on incomes over $5 million].

Donald Trump

  • Repeal the reviled “Death Tax.”
  • Stepped-up basis would be ended and built-in capital gains at death over $10 million would be subject to tax:
    • Small businesses and family farms exempted.
    • Contributions of appreciated assets into a private foundation established by the decedent or relatives would be disallowed (to prevent abuse).
  • Few details are enumerated, but presumably if the death tax were repealed:
    • Gift and generation skipping taxes would also be repealed, and
    • There would need to be an inferred carryover basis on inherited appreciated assets that would result in capital gains only upon a future sale or realization event. If not, there would be a deemed disposition tax similar to Secretary Clinton’s proposal, although at a lower 20% rate on assets held more than one year.

Ending “stepped-up” basis may be one of the few matters the two candidates agree upon. This is worthy of note because the loss of basis step-up of highly appreciated assets could result in capital gains tax higher than the estate tax. Depending on the final terms, it could apply to transfer assets in estates of all sizes, even if not subject to estate tax.

Internal Revenue Code Sec. 1014 currently provides for step-up in basis of assets to date-of-death fair market value. Carryover basis of assets (passing the capital gains tax along with the asset) was tried in 1976, but then repealed in 1980 due to the administrative mess of tracking and actually determining carryover basis. Your humble scrivener learned about these nightmares while studying estate tax in law school, only to have carryover basis repealed upon graduation. Perhaps our modern computer capacity will make such calculations more manageable for publicly traded securities where we know acquisition date and cost, but tracking basis of individual head of cattle on the family farm or individual nuts and bolts for the family hardware store might prove more bothersome.

More importantly, beneficiaries have historically received a stepped-up basis, avoiding pre-death capital gains taxes, and have been responsible for only after-death capital gains. Not only will substantial capital gains tax be owed, but this will apply to all estates, whether taxable [large] or not.

Our Democracy survived 2010, when there were temporarily no estate taxes in effect and executors could elect to use a modified carryover of basis rules. Perhaps we will be similarly fortunate with our next venture into carryover basis. What we need to be aware of, however, is that all beneficiaries may be paying capital gains taxes, no matter the size of the estate. We will go from a regime where incredibly few estates are taxable to a new regime where all estates may involve capital gains taxes. This would include portfolios of stocks and bonds, as well as the family homestead. This will turn out to be a much bigger deal than we will be informed of in advance…


Remember, it’s not what you make that matters…it’s what you keep!

The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

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End of Family Business Discount Transfers

by  /  Estate Planning, Estate Tax, News

We take a brief respite today from our retirement planning discussions to focus on BREAKING NEWS from the estate tax world.

  • On August 2, 2016 the IRS proposed new regulations under IRC Sec. 2704 (the “Regs”) that would, in most situations, prohibit the use of certain discounts customarily applied when valuing transfers of interests in family-owned corporations, partnerships and limited liability companies (“LLCs”).
  • A challenge faced by owners of closely-held businesses is how to transfer ownership to succeeding generations in a tax efficient manner (avoiding estate tax of 40%).
  • Taxpayers have traditionally taken valuation discounts for transfers of such interests of 25% to 40%, reflecting the fact that an interest in a family-owned business is restricted and not readily convertible into cash.
    • Owners of minority interests in a family business have been able to discount the value of the interest to reflect the reality that they do not have the voting power to control the entity and compel a dividend or a redemption of their interests.
    • Similarly, an owner of a minority interest in a family business has been able to claim a further discount for lack of marketability, reflecting that outsiders are reluctant to purchase an interest in another’s family business or the formation documents may limit any such transfer.
    • Discounting the value of the interest transferred by gift or inheritance, lowers the value that is subject to gift or estate tax, often referred to as discount or leveraged gifting.
  • Many estate planning techniques utilize valuation discounts to increase the amount of property that may be gifted or otherwise transferred to or in trust for family members. For example, Grantor Retained Annuity Trusts (“GRATs”) rely on discount gifting for much of their tax benefits.
  • Often these family limited partnerships (“FLPs”) and family limited liability companies (“FLLCs”) hold business, real estate or other commercial operations that are actually operated by multiple generations of the family, but sometimes FLLCs or FLPs are simply used as wrappers to hold marketable assets, such as publicly traded securities, in order to generate a discount value for transfer purposes. The IRS has long viewed such strategies as abusive, but has been unable to convince Congress to legislate the discounting away. Similarly, many court cases have focused on the reasonableness of the discounting, but still have permitted the practice. The Regs represent the IRS’s attempt to unilaterally end the discounts, without the help of Congress or the courts, similar to the effect of an executive order.
  • The Regs are very technical, but generally would treat the above restrictions to voting and transfers as if they would not be enforced by the family on its own members and, thus, would be disregarded when valuing the interest for transfer tax purposes.
    • The Regs would generally value an entity owned by family members by disregarding these discounts and valuing the owner’s interest as a pro-rata share of the total fair market value of the entity.
    • The Regs would also treat transfers made within three years of the transferor’s death as a date of death transfer, thereby increasing the estate value for transfer tax purposes.
  • After a ninety-day comment period, public hearings will be held on December 1st. The Regs may be effective as early as January 1, 2017.
  • This is yet another step in the limiting of estate tax planning techniques. Remember our earlier discussion of President Obama’s Budget Proposal provisions regarding:
    • reducing the unified credit from $5.4 to $3.5 million,
    • eliminating step-up in cost basis to date-of-death fair market value,
    • eliminating short-term GRATs and
    • eliminating dynasty trusts.

Watch for such of these items as may be enacted via regulation or executive order to be effected. These represent “low hanging fruit” for tax revenue enhancement.

  • Accordingly, any taxpayer owning or managing a family business has a closing window of opportunity in which to use the discount for minority interest and lack of marketability, thereby significantly lowering the value for transfer tax purposes. This represents the voiding by year-end of fundamental estate and gift planning tactics used for a long time. IF YOU OWN A FAMILY BUSINESS AND HAVE CONSIDERED ESTABLISHING, OR TRANSFERRING BUSINESS INTERESTS TO, AN FLP OR FLLC IN THE PAST, NOW IS THE TIME TO ACT… PLEASE CONTACT YOUR TAX ADVISOR ASAP. Advisors may be rather busy completing these projects for their clients before year-end. If you have issues we can help solve, please contact us.

Remember, it’s not what you make that matters…it’s what you keep!

The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.

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