Estate tax strategies heading into the election

Estate tax reform has been on everyone’s radar for years. Under a new administration, it’s possible some of the changes that have been discussed could come to pass sooner than expected. If this looks likely, there are some steps families may want to take in 2020 to take advantage of more generous rates today.

The changes we would focus on are:
• Possible increases in the estate tax rate (currently 40% but has been as high as 55% in the recent past).
• A possible rollback of the $11.58 million exemption from estate taxes sooner than expected, in 2021 rather than 2025 -- the exemption could fall to $5 million or less.
• A removal of discounting for the value of closely held family firms, which was in place to make up for the lack of marketability of these businesses.
• Changes to the rules around grantor retained annuity trusts, or GRATs.
• Capital gain recognition or reduced basis step-up upon death.
• Additional states adding estate taxes (only 12 currently have them).
• Changes to the way charitable contributions upon death are taxed.

As mentioned, the current federal estate tax exemption of $11.58 million per person will already be reduced by approximately half in 2026. This decrease could accelerate and decline even further if Democrats maintain control of the House of Representatives while taking over the Senate and the White House. As a result, more decedents may be subject to the federal estate tax of 40% or more (which can grow above 50% in some states) in the near future.

If these changes appear likely, taxpayers can look at ways to accelerate exemption use through direct gifts, spousal trusts or gifting partnerships. If some or all of the $11.58 million exemption can be passed down now, the estate tax won’t apply to that amount, but if you wait and it is rolled back, the estate tax will kick in on more of the inheritance.

Some other opportunities to consider that can help address possible estate tax changes:
• Intrafamily loans are another effective way to pass down wealth, with 1% long-term interest rates (and less for mid- and short-term loans).
• In some cases, gifting assets and paying the gift tax may be more advantageous than passing them down as part of the estate.
• Taking out a life insurance policy to manage the estate tax liability could make sense.
• If passing down a business, the discounts available now (and lower valuations during the downturn) may make it worthwhile to speed up the transfer.

The possible introduction of a capital gain recognition event at death is worth a special look. Essentially, under current estate tax rules, the 40% tax is applied to the current value of an asset and that asset receives a step-up to fair value basis in the hands of the inheritor(s). While it is not clear how the mechanics would work, new rules under consideration could apply in different ways with meaningfully different results.

Imagine an asset worth $4 million today, with a basis value (the amount originally paid for it) of $200,000. Upon death, the 40% estate tax on the $4 million is $1.6 million, leaving $2.4 million to the beneficiary with a stepped-up basis of $4 million.

In one proposed scenario, in addition to the estate tax, a capital gain tax would be applied on the gain of $3.8 million, minus the 40% estate tax already paid. In this case, the inheritors would be left with about $1.5 million (assuming a capital gain rate equal to the ordinary rate of 39.6%).

In a second scenario, there could be no deduction for the 40% estate tax in computing the capital gain tax. In this scenario, the value remaining to the inheritors from the $4 million asset would only be about $900,000.

As such, timely estate planning could result in meaningful benefits. If such dramatic changes are on the horizon, for example, it could make sense to pay taxes on an appreciated asset before these policies go into effect.

Of course, these proposals aren’t one-size-fits-all. The complexity and interconnectedness of estate planning decisions with income tax changes will require a thoughtful, careful evaluation to maximize advantage.

[More: Timely tax strategies on the eve of the election]

Mark Rubin is head of tax at Geller Advisors. Allen Injijian is the firm’s head of wealth strategy.