As Benjamin Franklin stated, “In this world nothing can be said to be certain, except death and taxes.” We all like certainty. We know how to plan. We know how to protect our loved ones. We know how to operate our businesses. Although death and taxes may be certain, what those taxes look like under a new administration is far from clear. President Trump has proposed different plans on what tax reform may look like, leaving wealth and estate planning professionals as well as the families and businesses they serve preparing to navigate the potential changes.
What changes are on the horizon?
- Repealing the Federal Estate Tax. Although it is doubtful any repeal would be permanent as the Republicans do not have enough votes to enact permanent tax reform (They need 60 votes, which would require some Democrats to vote for the reform which is unlikely given the fact that not all Republicans are on board for all of the proposed changes—including eliminating the estate tax).
- The Return of Carryover Basis. If the estate tax is repealed, the government will find a way to recoup the revenue loss elsewhere. Proposed plans discuss using carryover basis. This has a far greater impact on individuals, especially those with taxable estates such as our small business owners and farmers and ranchers. What is carryover basis? Currently, when you pass away your assets receive a step up in basis to the value of the asset as of the day of your death. So let’s say you own $500 worth of Apple stock when you pass away that you paid $1 for, after your death, the basis of that stock is $500—so there is no gain if your estate sells it for $500 or less. Most past estate tax repeal proposals have provided that you would lose that step up in basis so the value of the stock would remain at $1 and there would be $499 of gain when your estate sells the stock after your death.
- Increase in Capital Gains Rates. Further, there have been discussions of raising the capital gains rate, which would further increase the amount of taxes owed. For example, under the current law, $499 in gain at the 20% gain rate results in a $99.80 tax. Raising the rate would increase the amount of tax owed. Discussions range from a 33% rise all the way to doubling the current rates. For most businesses, farmers, and ranchers, this would result in far higher overall taxes than keeping the current system in place.
- Higher State Estate Taxes. Repealing the federal estate tax will also cause an increase in the amount of state estate tax owed in states that have an estate tax. Generally, most states allow an estate to deduct the amount of federal estate tax it pays from the state estate tax amount. Without a federal estate tax, the deduction will be lost resulting in a higher state estate tax.
What can you do now to protect your loved ones and your business?
- Think Ahead to How Your Beneficiaries Will Inherit. Using specialized trusts to transfer assets to beneficiaries for their benefit are still a great idea, regardless of the tax landscape. These long-term trusts may last for multiple generations and are designed to shield the assets from future estate taxes upon the death of the primary beneficiary at each generation. Although there is a limit to the amount of assets that can be shielded at the time these trusts are set up (currently a married couple can shield $10.98 million dollars), qualified estate planning attorneys should design these trust flexibly to maximize the amount that may pass estate tax free, regardless of what laws are in place at the time the grantor passes away. Further, many of these trusts are designed to provide the beneficiaries protection from divorce, creditors, remarriage, and provide succession planning to keep the assets in the bloodline.
- Protect Your Spouse while Maximizing Income Tax Planning. Set up trusts at the death of the first spouse that maximize the use of the federal estate tax exemption (if applicable) and provide income tax planning. Even if the estate tax is repealed, these trusts have other benefits. Generally, half of the assets are placed in a protected trust that not only shields the assets from divorce, creditors, remarriage, and provides succession planning to keep the assets in the bloodline, but they also allow the surviving spouse to maintain the step-up basis and potentially re-depreciate some or all of the assets back out or sell the assets without any gains implications.
- Be Ready for Change. The most important action you can take is to ensure your documents are up to date. During this unknown tax landscape, change may occur faster than anticipated and you may wish to take advantage of the current laws before the new laws go into effect. However, if your planning documents are not up to date, it may take your attorney more time (resulting in higher fees) which may impact whether or not you are even able to take advantage of the current laws. Families and businesses who have up to date documents are better positioned and will have more options when the time comes. Don’t be left behind, be sure your families estate planning documents have been reviewed in the past year. Further, have your attorney review your businesses operating agreement, buy-sell agreement, and any other foundational documents. To protect your family and business, you need to be prepared to act fast. What’s the worst that can happen? No tax reform is enacted and your documents are better designed to protect you, your family, and your business moving forward. Win-Win.
Why would I do any planning under this period of uncertainty—why not wait?
Repeal is not certain, and historically when the estate tax has been repealed, it has always been reinstated. But more importantly, why are you planning? Is it solely for tax purposes? Most of use create our business plans and estate plans for reasons far more important than ensuring we are being as tax efficient as possible. Of course, tax efficiency is a key component in any plan, but it is not the end game. We want to protect our family. We want to ensure that our family farm stays operational and our farming children are able to continue the family legacy. We want to ensure that our business is able to continue after our death and that our employees and loved ones in the business still have the ability to run a successful company. We want our children to benefit from our hard work and not see the assets squandered away or going to creditors or an ex-spouse. We want our grandchildren to be able to stay in the family cabin and know that the family name means something. We want to ensure our children are productive members of society and that they are protected if they have an unforeseen medical expense or diagnosis. We want our families to appreciate the hard work of previous generations and look to build on that success and family heritage.
At the end of the day, being tax efficient is important, but it is not the end game. Protecting your loved ones and your life’s work is WHY you plan, it is why you put the time, energy, and resources into putting together a well-thought out estate and business plan and why you review that plan every year or so. Death and taxes may be certain (or uncertain under a new administration), but our goals and desires of HOW our beneficiaries will inherit when we pass does not change with the tax code. Provide your loved ones and business with the clarity, simplicity, and peace of mind in knowing that they are protected in the event of your death or disability.