Estate Tax Repeal: What Would It Mean for Estate Planning?

Estate Tax Repeal: What Would It Mean for Estate Planning?

If the Republican-controlled Congress and White House have their way, it’s likely that legislation will be introduced in the near future to repeal the federal estate and generation-skipping transfer (GST) taxes (the future of the federal gift tax is uncertain). But the demise of these taxes would not mean the death of estate planning. For one thing, much of estate planning focuses on areas other than federal taxes, including guardianship of minor children, asset protection, family business succession, and state taxes. In addition, repeal would create new planning opportunities for clients to protect their wealth against restoration of federal transfer taxes in the future.

Nothing in Tax Law is Permanent

Even if the estate and GST taxes are repealed, there’s a good chance they will be revived at some point down the road. One possibility is that, to facilitate passage of the legislation, Congress will accomplish repeal through the budget reconciliation process, which would require the law to “sunset” in 10 years. But even if the repeal is “permanent,” there’s no guarantee these taxes won’t be revived by a future administration and Congress.

Creating a Dynasty

The dynasty trust is a powerful tool affluent families can use to allow wealth to grow free of federal transfer taxes for many generations. These trusts are particularly valuable now that an increasing number of states permit them to last for hundreds of years or even forever.

Under the current tax regime, the amount one can contribute to a dynasty trust is effectively limited by federal transfer taxes — in particular, the GST tax. This tax, which applies in addition to the estate tax and at the highest marginal estate tax rate, is imposed on transfers to or for the benefit of grandchildren or others who are more than one generation removed. The key to avoiding GST taxes is to limit trust contributions to one’s unused GST tax exemptions (currently, $5.49 million, which is identical to the lifetime estate and gift tax exemption).

Repeal of the estate and GST taxes would create an opportunity for people to shield unlimited amounts of wealth by taking advantage of testamentary (that is, established at death) dynasty trusts. Of course, these trusts would have to be modified if the estate and GST taxes are revived before the donor dies. However, if the gift tax is also repealed, there will be a rare opportunity for people to permanently protect an unlimited amount of wealth against future transfer taxes by contributing them to an inter vivos (that is, established during life) dynasty trust.

The fate of the gift tax is uncertain — the President’s tax proposals have been silent on the subject. You may recall, however, that when the estate and GST taxes were briefly repealed in 2010, the gift tax survived.

Potential New Taxes

Even if the estate and GST taxes are repealed, there’s a strong possibility that they will be replaced with new taxes. Alternative taxes being discussed include:

• A new tax on unrecognized capital gains held at death, with the first $10 million tax-free.
• A carryover basis regime, in contrast to the current stepped-up basis regime. That would mean that heirs who inherit property would retain the decedent’s basis, remaining liable for any appreciation in value in the event they sell the property.

It’s too soon to predict what lawmakers will do, but one thing is certain: Any changes to the federal transfer tax system will require advisors to develop new tax-planning strategies for their clients.