President-Elect Donald Trump has proposed the repeal of the federal estate and gift tax to be part of his tax reform policies upon assumption of office. This proposal is likely to come to fruition with a Republican controlled Congress. The elimination of the federal estate and gift tax unlocks significant tax planning and wealth transfer opportunities for families traditionally constrained by the $5 million lifetime transfer exclusion. There are, however, potential tax consequences for the receiving beneficiaries that warrant additional consideration.
At the moment, the lifetime transfer exclusion is set at $5.49 million ($10.98 million for married couples) for 2017. Under current tax rules, any transfer of assets valued over these thresholds could result in a 40% tax on the transferor or transferring estate. This high tax rate is partially offset by the step-up in basis to the beneficiaries of the estate. This removes the tax burden from the gift recipients who ultimately sell or dispose the gifted assets. Annual gifts of $14,000 per gift recipient are excluded from these calculations.
Under President-Elect Trump’s plan to repeal the federal estate and gift tax, families can transfer unlimited gifts and assets between direct descendants and skip-generation descendants with no immediate tax consequence. This potential change in tax rules presents unique opportunities for tax planning and the ability to fund future generations with little or no tax outlay. Consider the following example. A couple gifts $100 million in appreciated stock to their children and grandchildren who then sell off the stocks incrementally to fund their cost of living. Assuming that favorable capital gains rates persist, the children and grandchildren could potentially pay 0% federal tax on the sale of the stocks if they keep their income under certain thresholds. If they are in the highest tax brackets, the highest potential capital gains rate the children and grandchildren could face would be 20%.
The caveat to this situation is the loss of basis step-up. This means that the transferred assets retain the holding period from the original purchaser as well as the original cost basis. If large amounts of assets or a single large asset with this carryover basis is sold in one taxable period, significant taxable gains could be recognized by the gift recipient. This could present a challenge to the gift recipient if he/she is cash constrained.
It is important to remember that the elimination of the federal gift and estate tax has not yet occurred and could potentially not occur. Specific terms and rules, especially those that apply to individuals with estates under the current exclusion thresholds, are not set. State conformity will vary and additional considerations may be necessary, especially for those considering making irrevocable gifts in the near future.
Given the fluidity of the situation and the costs and benefits associated with the potential repeal of the estate and gift tax, a conversation with your tax professional may be warranted. Please feel free to contact us at 858-588-9200 with any questions or concerns.