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Financial Planning > Trusts and Estates > Estate Planning

GOP Tax Plan Increases Need for Estate Planning Flexibility

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While the Republican tax reform framework clearly calls for a complete repeal of both the estate tax and the generation skipping transfer (GST) tax, the lack of details offered by the plan has created a confusing planning environment for clients—especially high net worth clients.

(Related: New GOP Tax Framework Includes Caregiver Tax Credit)

If one thing is certain, it is that the framework creates an era of uncertainty for clients whose estates would be valued above the estate tax exemption amount (currently $5.49 million per individual).

Despite the fact that the administration has made its support of estate tax repeal clear, estate planners cannot be sure what shape future legislation might take, or whether an estate tax repeal would even be permanent.

The uncertainty means that developing flexible strategies to minimize transfer taxes remains just as important as ever.

Unanswered Questions

The GST tax is imposed on a transfer of property by a donor to a grandchild or great-great-grandchild through a will or trust.

The tax reform framework proposal would eliminate the estate tax and the GST tax, but it makes no mention of the current federal gift tax structure.

Under current law, clients may transfer up to $14,000 per year to each donee during life without triggering the gift tax. (Spouses may elect split gift treatment, so that the $14,000 amount is doubled to $28,000 per married couple). Lifetime gifts above and beyond this annual gift tax exclusion amount are taxed at the 40% gift tax rate.

Although the framework does not address the gift tax, it is widely expected that some form of the gift tax will remain, in order to prevent income tax evasion. (Evasion could, for example, be accomplished by having a taxpayer make lifetime gifts of property to family members in lower income tax brackets).

IRS building (Photo: Allison Bell/TA)

(Photo: Allison Bell/TA)

The tax reform framework also makes no mention of the currently existing “step up” in basis that applies to property transferred at death. The step-up rules adjust the basis of property transferred at death so that it equals the fair market value of the property at the date of death. (In other words: The property value used for estate tax purposes.) That system lets heirs avoid paying capital gains taxes on the appreciation in property value that occurs before the heirs eventually transfer the property.

If the estate tax is eliminated, it is possible that the stepped-up basis provisions would also be eliminated—essentially implementing a carryover basis regime that would apply capital gains tax rules to property transferred at death. Others predict that a limited step up in basis could be created to shield only property valued under a certain dollar threshold from capital gains taxation.

Transfer Tax Concerns

Because of the uncertainties surrounding potential modifications to the current transfer tax regime, flexibility in planning for both lifetime and testamentary gifts becomes especially important. Flexibility is also key to ensuring that clients are not stuck with an undesirable estate plan in the event that the estate tax is repealed and eventually reinstated by a subsequent administration.

As a result, clients should consider giving independent trustees power to make changes to the allocation of trust assets (such as: a power of substitution to allow the trustee to exchange trust assets for assets of equal value) in response to changes in the estate and GST tax rules that occur over time. This extra trustee authority can help a client avoid an unfavorable tax outcome if the rules governing the tax basis of assets transferred at death are changed.

Powers of appointment can also be useful in allowing for changes in beneficiary designations or trust terms. Similarly, certain states (Delaware, for example) have passed modification rules that can allow for more substantial modifications of irrevocable trusts, with the consent of certain parties.

Generally, because of uncertainty in the gift tax area, clients should continue to be advised to avoid large lifetime gifts, to avoid attracting substantial gift tax liability.

The Expectations Trap

Although clients may be tempted to rely upon the possibility of complete estate tax repeal, it’s important that they be reminded that the rules governing transfer taxes change frequently.

Even so-called “permanent rules” can be repealed.

Given the reality that the rules can change, maintaining flexibility is key to minimizing transfer tax liability in the long run.

This article comes from Tax Facts Online, a ThinkAdvisor sister site that provides a rich source of in-depth tax news, information and analysis. To sign up for access to that site, go here.

Once you’ve signed up for Tax Facts Online, you can see the site’s previous coverage of transfer tax planning strategies, in the Advisor’s Journal section, here

You can find analysis of federal estate tax issues in the Advisor’s Main Library, here.

You can also post questions for the site managers on their Advisor FYI blog. 


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