By James K. Treadwell
With the election of a Republican president and a continuation of Republican control of both the U.S. Senate and the U.S. House of Representatives, significant modifications to the federal taxation of wealth transfers may well be in the offing.
Given the absence of a 60-seat Republican majority in the Senate, there is no guarantee that such modifications would be permanent. As was the case with the Bush tax cuts of 2001, such modifications as are made would likely expire or “sunset” 10 years after enactment, in which case there would be a restoration of the federal transfer tax regime in existence today.
Whether changes are temporary or permanent, it is possible that there would be a repeal of the flat 40-percent federal estate tax that presently applies to estates having a value in excess of $5,450,000. In the plan proposed by the 2016 House Republican’s Tax Reform Task Force Report, the elimination of the federal estate tax would be accompanied by a basis step-up of virtually all of a deceased person’s assets to their fair market value at death, such that the capital gain tax exposure to those inheriting assets would be significantly less than it would have been to the decedent.
This is a feature that has long been in place to soften the impact of the estate tax on assets passing at death. Under the House Republican proposals, it would apply to inherited assets even though they have not been subject to estate taxation.
Though the section of the Trump campaign website dealing with tax reform clearly advocates for the elimination of the federal estate tax, it does not call for as dramatic a basis step-up as is proposed in the House Republican proposals. It provides instead that, “capital gains held until death and valued at over $10 million will be subject to tax.” It is unclear as to whether such gain would be taxed at the decedent’s death (as is presently the case in the Canadian tax system) or later upon the eventual sale of inherited assets.
The Washington estate tax will likely be unaffected by the federal changes. Washington residents and those holding property subject to Washington estate taxation will likely continue to be subject to a tax topping out at 20 percent on their assets in excess of their exemption amounts (the general exemption currently being $2,079,000 adjustable for inflation). This tax is deductible for federal estate tax purposes under the current regime. Assuming something less than a full basis step-up at death, the manner in which the Washington estate tax might factor in the calculation of an inheritor’s capital gain tax is an open question.
The fate of the federal generation skipping transfer tax and the federal gift tax is also uncertain. The Trump campaign proposals are silent as to these two forms of transfer taxation. The House Republican proposals would repeal the generation skipping transfer tax, but are silent as to the federal gift tax. There is neither a Washington generation skipping transfer tax nor a state gift tax.
The Trump campaign proposals also include a disallowance of income tax deductions for contributions of appreciated assets to private foundations and a capping of itemized deductions to an annual $100,000 ($200,000 for joint returns). The House Republican proposals contain no similar provisions. Both the Trump and House Republican proposals reduce income and capital gains tax rates from their current levels.
Proposed regulations under Internal Revenue Code 2704 dealing with transfers of interests in closely held businesses and family holding companies were pending at the time of the election.1 Given the prospective repeal of the federal estate tax, these proceedings may be suspended, though as of the publication of this article, the IRS hasn’t indicated that this will be the case.
The prospective disallowance of entity valuation discounts for transfer tax purposes may apply to the Washington estate tax even if the federal estate tax were to be repealed, in which case it would have behooved clients to have availed themselves of the valuation discount benefits under the existing law should the proposed 2704 regulations become final. Taking this into account and considering the asset protection and family management attributes of family holding companies, clients will be wise to seriously consider the pros and cons of current transfers of entity interests and/or the formation of such entities now.
It is possible that the very first round of the new administration’s legislative proposals will include transfer tax modification. As specific proposals develop, appropriate planning will be in order. Until then, and except as to closely held business and family holding company considerations, we will be assuming a wait-and-see posture.
James K. Treadwell is a shareholder at Karr Tuttle Campbell in Seattle where he maintains a practice focused on estate planning, and trust and estate administration.
1 See Jim Schneidmiller, “Proposed Regulations Impact Estate and Gift Tax Planning for Family-
Business Owners,” KCBA Bar Bulletin, October 2016 at 9: https://www.kcba.org/newsevents/barbulletin/BView.aspx?Month=10&Year=2016&AID=article4.htm.
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