Estate Tax Reform

Outlining the Plan for Tax Reform – Estate Taxes

By Matthew E. Miller, CPA, MBA

Lately, the news cycle has been filled with information about the Administration’s proposal for tax reform.  Position statements by members of Congress, statements by members of the Administration, as well as network news spins on political positions make it difficult for many Americans to understand the meaning and impact of the reform proposals.  Over the next few months, we will share our thoughts on specific targeted areas of reform and break down the rhetoric into unbiased language that is more easily understood.

Where tax reform goes is anyone’s guess. Prudence requires us to monitor events and be mindful of possible changes, but not yet take action. As the fall term goes on, we may see clarity added to the reform plan and may eventually learn whether major tax legislation will be enacted.  We will try to unspin the news and breakdown what you are hearing to help you understand how tax reform will impact you.

We hope you find our reports helpful and informative.

Estate Taxes

You’ve heard that one of the areas of reform includes the repeal of estate taxes. Most of us don’t pay attention to estate taxes. Be it because we think our estate value won’t ever be large enough to be subject to the tax or be it our natural aversion to the thought of our own mortality, the reality is, we don’t manage the tax consequences of our estate. Yet, we should.

Last weekend, I was reading an article “Trump Tax Plan: What the Death of the Estate Tax Really Means for Average Americans” where the author, Mr. Dan Caplinger, states many correct facts:

  • For 2017, estates valued at $5.49 million or less pay no tax.
  • In 2015, about 2.7 million Americans died.
  • In 2015, less than 12,000 estate returns were filed for the 2.7 million deceased taxpayers.
  • In 2015, only 5,200 estate returns resulted in tax due.

The analytical take away is very few estates of deceased American taxpayers result in a payment of federal tax (0.193%).

While, statistically less than 0.2% of deceased American taxpayers pay tax on the value of their estate, 100% of us benefit from the estate tax laws. In my opinion, this is the area of tax reform you need to pay the most attention to.  Repeal of the federal estate tax could/will affect your parents, you, and your children.  Follow me for a minute…

An individual’s estate currently has an exemption from tax of $5.49 million net value of assets, which can be $10.98 million for married couples.  So, as correctly illustrated in Mr Caplinger’s article, relatively few taxpayers owe estate tax anyway.

We think “great, I would support the repeal of estate tax.” 

Many economists, scholars, and conservative commentators argue the government taxes our income once when we earn it, why should they tax it again when we die?  Other economists, scholars, and liberal commentators argue repeal of the estate tax mostly benefits the wealthy.  Both point that have some merit, until you understand the scope of the tax and mechanics of the tax.  Stay with me…

Again, less than 0.2% of 2015 decedents filed estate tax returns that resulted in any tax paid to the Department of the Treasury.  Why so little, two reasons, the first being that building an estate of $5.49 million is a big hurdle to cross.  Most Americans won’t get there.  Second, for those Americans whose estates exceed the threshold, they have advisors who create trusts and other vehicles to shelter these estates from any estate tax.  As Gary Cohn, Chief Economic Advisor for President Trump, recently said “Only ‘Morons’ Pay the Estate Tax.”  Thanks Gary!  Maybe in your world this is true, but for most Americans, passing their estate to their heirs is a worry and a concern.

I’ll repeat, less than 0.2% of 2015 decedents filed estate tax returns that resulted in any tax paid to the Department of the Treasury.  However, 100% of the beneficiaries of an estate benefit from the estate tax for one reason, Asset Basis Adjustment.  For non-retirement assets, IRC Section 1041 allows for the step-up (or step-down) in the value of each asset (basis) held in a decedent’s estate.  This is an invaluable tax benefit to the heirs.  Here is our example:

Example

Tom has a projected estate of $1.3 million which consists of the following non-retirement assets:

Asset Original Cost      FMV
House $ 550,000 $   800,000
Cash $   80,000 $     80,000
Stocks $ 150,000 $   375,000
Furnishings $   45,000 $     45,000
Total $ 690,000 $1,300,000

Since Tom’s estate is less than $5.49 million, no federal estate return needs to be filed.  But, the importance of properly accounting for the assets of the estate is the determination of the FMV step-up in the value of the appreciated assets.  Tom’s heirs will inherit his assets at FMV on the date of Tom’s death.  As the heirs sell the assets, they will have little or no tax to pay on the sale of the assets assuming the selling price of the assets is close to the FMV basis established by the inheritance.

Without a federal estate tax, presumably there is not a basis step-up.  As such, Tom’s heirs would inherit Tom’s basis at his original cost.  The sale of these assets will result in a $610,000 gain which will be taxed at a rate equal to the federal capital gain rate, plus the state income tax rate and will be paid by Tom’s heirs.

You may or may not recall for the first time since 1916, there was no estate tax in 2010.  As a result, heirs of estates for decedents dying in 2010 would have missed the opportunity for a basis adjustment on inherited assets but for an act of Congress.  In 2011, the estate tax reinstated and the exemption was set at $5.0 million.  Executors managing estates for a decedent who died in 2010 could chose to follow the 2010 rules excluding all assets from the tax and forgoing the basis step-up or apply the 2011 exclusion of $5.0m and step-up the asset basis.

One of the more notable decedents in 2010 was George Steinbrenner, owner of the New York Yankees.

In summary, few American taxpayers find themselves subject to the federal estate tax. However, all American taxpayers benefit from the laws covering federal estate tax.  Please pay attention to this legislation.