Republicans’ Estate Tax Repeal Plan Should Put Planners on Notice

Republicans’ proposed legislation to repeal the federal estate and generation-skipping transfer taxes could create additional complexities for estates that use formula clauses, rely on portability, or involve multigenerational wealth planning.

If the estate tax is repealed, all holders of estate plans with potential estate tax liabilities should review those plans and update them if they no longer fulfill the grantors’ intent or involve tax inefficiencies.

Most estate plans that may face estate tax liability use formula clauses, which designate to a trust an amount tied to the estate and generation-skipping transfer tax exemptions. These clauses generally are used by estates with an anticipated value over $7 million—the estimated estate tax exemption that would take effect on Jan. 1 if certain Tax Cuts and Jobs Act provisions aren’t renewed.

Formula clauses help estates pass assets more tax efficiently because the exemption amount is adjusted annually for inflation. They’re common for high-net-worth taxpayers, so a repeal of the estate and generation-skipping transfer taxes would require redrafting estate plans to reflect the grantor’s intent. Failure to do so may open the door to increased estate tax litigation.

Some estate plans for married taxpayers who have a net worth around the estate tax exemption amount use portability rules instead of a formula clause.

Estate plans that rely on the portability rules usually give most assets to a surviving spouse using the unlimited marital deduction and then file an estate tax return electing to add the deceased spouse’s remaining estate tax exemption to the surviving spouse’s estate tax exemption.

Repealing the estate tax would mean there’s no election to make. If the estate tax were subsequently brought back through future legislation, the impact on portability during the period when the tax was repealed would need to be determined.

Estate planning must be balanced against income tax planning because most assets beneficiaries receive, through an estate, get favorable income tax treatment in the form of a step up in basis, compared with gifts made during a grantor’s life, which receive carryover basis.

Consider a taxpayer who bought a stock for $10 that’s now worth $100. If the stock is gifted, the beneficiary may sell the stock and pay capital gains tax on the difference between the sale price and the original owner’s purchase price or the basis as the amount a taxpayer has invested in an asset. This will result in a taxable $90 gain to the beneficiary.

If that same stock is bequeathed through the taxpayer’s estate, then the beneficiary’s basis for income tax purposes is “stepped up” to the date-of-death value of $100, essentially eliminating the $90 taxable gain.

These income tax rules apply to all taxpayers, whether they’re subject to the estate tax or not. High-net-worth individuals benefit from this, as they may have wages or other sources of income to use during their lifetime. They also may take out loans against the stock, which is an estate tax deduction. At death, the taxable gain in the value of the stock essentially is erased.

A repeal of the generation-skipping transfer tax may affect individuals at the top end of the wealth spectrum—usually those with a net worth over $100 million. This tax is imposed on transfers exceeding the exemption amount to individuals who are two or more generations below the grantor—typically grandchildren and future generations.

Because there are generally numerous individuals in a family, each with their own estate tax exemption, it usually takes wealth above all those combined exemptions before the generation-skipping transfer tax becomes significant.

Repealing the generation-skipping transfer tax would create uncertainty for trusts already established using the exemption, because there would be no rules to further allocate to it. If so, taxpayers and their advisers may want to set up new trusts to avoid commingling pre- and post-repeal assets, given that future legislative changes to the generation-skipping transfer tax are unpredictable.

The proposed legislation doesn’t call for repealing the gift tax, only estate and generation-skipping transfer taxes.

The lifetime gift tax exemption would be the same as under current law—$13.99 million adjusted for inflation. This may prevent large asset shifts, because gifting during life would be subject to a 35% gift tax on the value of any assets gifted above the exemption amount. Conversely, if the asset transfer occurred at death, there would be a zero-rate wealth transfer tax.

Under current law, gifting is tax advantageous for large estates because the value of the gift, and the amount of exemption used, is determined on the date the gift is made.

For high-growth assets, the savings expected from estate tax may offset the carryover basis for gifts, instead of the basis step-up and related income tax savings if held in the taxpayer’s estate.

Estate planners should help high-net-worth clients conduct plan analyses with the possibility that future administrations may reintroduce the estate and generation-skipping transfer taxes that include health and age of the grantor, along with the type and anticipated growth of assets.

Current law provides a $13.99 million exemption per person on the transfer of assets that may be used for lifetime gifting and/or transfers at death through a taxpayer’s estate, along with the same $13.99 million exemption from generation-skipping transfer tax.

The estate, gift, and generation-skipping transfer taxes are all imposed at a 40% rate on amounts above the exemption, assessed depending on the time of the transfer and the receiving beneficiary.

Repealing the estate and generation-skipping transfer taxes may complicate plans in place and uncertainty in estate planning going forward.

Estate plans that were drafted with an anticipated estate tax liability should be reviewed, if the estate and generation-skipping taxes are repealed, to update taxpayer intent of the assets and timing of distributions to the beneficiary or for transfer and income tax efficiencies. Any redrafting also should contemplate the possibility the taxes could be reinstated.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Abbie M.B. Everist is principal in BDO’s national tax office, private client services, and vice chair of the American Bar Association’s generation-skipping transfer tax committee.

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