Tax Changes on the Horizon: What To Expect in Federal Estate, Gift and Generation-Skipping Transfer TaxesOctober 2, 2017 – Alerts
Since July 2016, there have only been incremental changes to the federal estate, gift and generation-skipping transfer taxes and related income tax rules, and to the Washington estate tax rules.
Here is a summary of the rules as of early October 2017:
- The federal estate tax is still in effect and has a $5,490,000 exemption per person (the 2011 $5 million exemption amount as indexed for inflation), and still has a 40 percent flat rate.
- The $5,490,000 exemption also applies to the federal gift tax and generation-skipping transfer tax, along with the 40 percent flat rate.
- The federal estate tax portable exemption rule – which allows a surviving spouse to receive any unused federal estate and gift tax exemption of the deceased spouse – remains in effect. Our clients now use it frequently, sometimes to facilitate long-term income tax planning (more on that below).
- The federal gift tax “annual exclusion” is still $14,000.
- The beneficial “step up in income tax basis” rules continue in effect.
- Surviving spouses, in conjunction with making a federal estate tax portable exemption election, are making otherwise unnecessary federal estate tax marital deduction elections to obtain a second step up in income tax basis. In 2016, the Internal Revenue Service confirmed that this strategy works. Let us know if you would like to know more about it.
- The 2013 federal income tax and capital gains tax rates are still in effect, with a maximum income tax rate of 39.6 percent and a maximum capital gains tax rate of 23.8 percent (20 percent plus the 3.8 percent Medicare surtax). Trusts and estates still pay at the highest possible income tax rates – 39.6 percent for 2017 taxable income in excess of $12,500.
- The Washington estate tax exemption for decedents dying in 2017 is $2,129,000 (calculated from the $2 million exemption set in 2006 plus inflation adjustments since 2013), its gross rates range from 10 to 20 percent, and it is still a deduction against the federal estate tax. While changes to the federal estate tax appear to be likely (more on that below), Washington estate tax rules seem unlikely to change in the foreseeable future; for example, Washington still has no portable exemption rule.
Possibility of Federal Estate Tax Repeal
In 2016 President Donald Trump said he wanted to repeal the federal estate tax. The Trump Administration and the Republicans in Congress now want to repeal both the federal estate tax and the federal generation-skipping transfer tax. So far, we have little in writing to go on – this is all we know as of early October 2017.
The key questions we are monitoring:
- Will the Trump Administration and Congressional Republicans be able to agree on a repeal bill?
- Will repeal be part of an overall tax reform package that includes problematic proposals (such as the so-called “border adjustment tax” proposal)?
- If the federal estate tax is repealed, will the repeal be permanent? Or will it be for only 10 years? (The critical factor here is whether Republicans are able to obtain 60 votes in the Senate. If not, they must use the budget reconciliation process and cannot make the repeal permanent.)
- How will repeal of the federal generation-skipping transfer tax work? Should we amend wills and revocable trusts so that assets are sheltered from estate taxes – including the Washington estate tax – for an extended period, (perhaps 150 years) under Washington’s Rule Against Perpetuities?
- What about the federal gift tax? If a 10-year federal estate tax repeal occurs and there is no gift tax, will it be possible to make substantial gift transfers that avoid the federal estate tax if it someday returns? If there is still a gift tax, can we use the federal estate and gift tax exemption to establish a generation-skipping trust?
- Will the beneficial “step up in income tax basis at death” rules also be eliminated? If they will, what, if anything, will replace them?
- What if the federal income tax rates do decrease significantly? Would it be beneficial to make income tax-advantaged gifts now, in 2017, before the change becomes effective (for example, charitable gifts)?
Avoiding the Washington Estate Tax
There are still good ways to avoid the Washington estate tax, including major lifetime gifts, even deathbed gifts (because Washington has no gift tax) and, as a last resort, moving out of Washington. In addition to making preparations to move, such as purchasing a residence in another state and establishing a revocable living trust, there are two factors our clients are beginning to consider:
- If the federal estate tax is repealed, the deduction for Washington estate tax will be eliminated, and the effective maximum Washington rate will rise from 12 percent to 20 percent, because there will be no more flat 40 percent federal estate tax rate.
- If the Congress eliminates the step up in income tax basis and replaces it with a deemed sale at death system, dying in Washington on balance might be beneficial, because Washington has no state income tax.
Lifetime Giving Opportunity
In the fall of 2016, the Treasury Department proposed regulations under Internal Revenue Code Section 2704 that would likely eliminate the minority and lack of marketability discounts used in valuing family business interests for lifetime gifts and gifts at death. In Notice 2017-38, however, the Treasury Department included these regulations in a list of eight regulations requiring further study due to the potential financial burdens on taxpayers. For the time being the Section 2704 proposed regulations are unlikely to be enacted.
Clients who have an interest in making gifts of family business interests – including gifts to generation-skipping trusts – should consider making the gifts now, particularly if the federal estate tax is not repealed in 2017.
Finally, two significant new Washington laws – one from 2016 and one from 2017 – are worth considering in updating your documents:
- As mentioned in our July 2016 client alert, many clients are updating durable powers of attorney because of Washington’s 2016 Uniform Power of Attorney Act.
- Effective July 2017, Washington enacted a version of the “Uniform Trust Decanting Act,” which provides a simple and low-cost procedure for updating out-of-date, obsolete irrevocable trusts. While Washington trust law continues to allow modification of irrevocable trusts using its “nonjudicial binding agreement” procedure, in many situations this new “trust decanting” procedure is better.
For more information on this alert, please contact Michael D. Carrico at [email protected], James W. Minorchio at [email protected] or Rachel Schaefer at [email protected], or please call at 206.624.3600.
If you have other questions about estate planning and related tax planning, please contact any member of the firm’s Taxation & Wealth Planning practice group.