By Mitchell Barr, Client Associate
The Estate Tax is one of the largest concerns for wealthy families and individuals in the United States. The tax has been in place since 1916, marking 100 years of the “death tax” as we know it today. Currently, the federal estate tax exemption is $5.45 million per individual ($10.9 million for families) and the top tax rate is 40 percent. This exemption amount is indexed for inflation and will continue to rise under current law.
For people with net worth over these exemption amounts, it is important to reduce their taxable estate through proper planning, as much as possible before death, or 40 percent of everything above the excluded amount is going to Uncle Sam. There are many strategies to accomplish this that are beyond the scope of this article, but currently many estates are able to avoid this tax all together if they gift wealth throughout their lifetime to charity and use the $14,000 per year tax-free gift exemption for other gifts.
All families currently enjoy a step up in cost basis on assets that are passed on at death. When your mother passes away with a hundred shares of Apple stock that she bought in 1995, all of the unrealized gains in that position are essentially forgotten by the IRS and you inherit the shares as if you bought them at the market value on the date of her death (IRS.gov).
You may be aware that there is an election going on, and with a new president can come new policies. The estate tax has changed frequently throughout history. When it was created in 1916, the exemption was $50,000 and the top rate was 10 percent. From 1942-1976, the top estate tax rate was its highest ever at 77 percent on anything over $60,000. In 2010 there was no estate tax after Congress failed to extend the existing legislation before it expired. The last time it was changed was in 2013, when the current exemption and rates were put into place (http://www.irs.gov/pub/irs-soi/ninetyestate.pdf). Both of the presidential candidates in this year’s election have their own plans for the estate tax, and there will be ramifications for high net worth estates under both proposals.
Hillary Clinton’s plan is the more aggressive of the two candidates. Her most recent proposal is to reduce the exemption to $3.5 million from $5.45 million, returning it to 2009 levels. According to The Wall Street Journal, the marginal rates would be as follows:
A 45 percent marginal rate on many estates with assets between $3.5 million and $10 million. Beyond that $10 million threshold, a 50 percent rate would start kicking in, then a 55 percent rate would start at $50 million. The top rate of 65 percent would affect only those with assets exceeding $500 million for a single person (http://www.wsj.com/articles/clinton-seeks-big-jump-in-estate-tax-1474588735).
In addition, Clinton would remove the step up in basis and force the realization of any gains in the estate at death (you will owe taxes on mom’s Apple stock), resulting in double taxation of appreciated assets.
Donald Trump’s proposal aims to repeal the explicit estate tax, but it still includes the elimination of a step up in basis at death for some estates. “The Trump Plan will repeal the death tax, but capital gains held until death and valued over $10 million will be subject to tax to exempt small businesses and family farms” (DonaldJTrump.com). In short, taxes on gains would still be due upon death, but the gain must be $10 million or greater, which would exclude many family and individual estates.
At this point, both of these scenarios are just proposals. In today’s world, the passing of legislation is unpredictable at best, no matter who gets elected, so we have no way of knowing if either plan will come to fruition. Also, there could be tweaks such as the elimination of the step up in basis, but taxes aren’t levied upon death (known as carryover basis). However, we cannot simply ignore proposals that will fundamentally change estate plans for wealthy families and individuals. At particular risk are families or individuals with large, illiquid assets, such as businesses or real estate, where cash is not available to pay the large tax levies at death.
We will continue to stay ahead of potential changes and keep you informed. Our goal may be to help you “live the life you imagined,” but we are also here to make sure that your wealth is preserved when that life is over.
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