By Kevin Alerding and Kristine Bouaichi
After a number of years of relative certainty, there have been several recent developments worth noting that could impact federal estate and gift planning.
Following months of limited detail in late September, President Trump rolled out an initial structure for tax reform called “Unified Framework for Fixing Our Broken Tax Code.” Consistent with his campaign platform, the Framework included federal estate tax repeal as part of the proposal.
But a repeal of the “death tax” might not make the final cut if concessions must be made to move forward other components of the Framework. Currently, it appears federal income tax will be the primary focus of tax reform measures. This seems to be a natural priority given it affects vastly more people than the federal estate tax, and a tax cut for corporations has been touted as a driver of economic growth. Further, the income tax generates a much greater proportion of the federal government’s revenue. As the Framework converts to proposed legislation and the party battle lines are drawn, income tax reform seems more likely to succeed than a repeal of the estate tax.
Related to wealth transfer taxes, there is stark disagreement about whether to repeal the estate tax. Even if a repeal gains favor, there seems to be no consensus in Congress as to what type of transfer tax, if any, might take the place of the federal estate tax. Although not often a focus for taxpayers, there is a meaningful risk that a “death tax” repeal could give way to another form of tax. Trump’s earlier proposal included an elimination of the step-up in cost basis on capital assets held by an estate, with an exemption for the first $10 million of value. If this type of structure were implemented, it is unknown whether a capital gains tax would be imposed immediately upon death for estates meeting this threshold or only when the assets are sold.
Even if there is a full repeal of the federal estate tax, it is unlikely to be permanent. Similar to the Bush-era tax reform measures, there would likely be a 10-year limit on changes. Further, because of opportunities for shifting taxable income to lower tax brackets, it also seems unlikely there would be a repeal of the gift tax on lifetime transfers of wealth.
Regardless of the status of the federal transfer tax regime, we are encouraging our clients to implement planning that addresses wealth and business succession planning goals. If possible, plans should not trigger the lifetime gift tax until more is known about the structure to come. But annual exclusion gifts ($14,000 per person in 2017, increasing to $15,000 per person in 2018) and transfers that use the lifetime gift tax exclusion (up to $5,490,000 in 2017, increasing to $5,600,000 in 2018) remain elements of smart planning. Other non-tax goals, such as asset protection, incapacity planning and encouraging productive behavior continue to drive plan structures.
In another recent and positive development, the Treasury Department has now withdrawn the so-called “2704 proposed regulations.” These proposed rules were first circulated in August 2016 and addressed the valuation, for wealth transfer tax purposes, of interests in family-controlled entities. In the simplest terms, the proposal threatened to eliminate the long-standing and statistically established valuation practice of allowing discounts related to business interests that lack a controlling vote or for which there is a limited (or non-existent) market for resale.
The proposed regulations were quickly met by strong opposition from family-business owners, estate planners and tax professionals. The Treasury issued the proposed regulations under the guise of eliminating “abusive” valuation discounts, but they were read by the taxpayer community as too broad and unworkable. Business and trade associations immediately raised concerns about the regulations negatively impacting active and operating entities and greatly limiting the ability to pass on the family business to the next generation.
Shortly after taking office, Trump announced a freeze on any new regulations. This was closely followed by his order to review regulations for oppressive taxpayer burden and cost. In late January, the Treasury announced it was considering exempting closely held businesses from the 2704 proposed regulations. However, commentators continued to raise concerns, because the definition of a “closely held business” would be key to the scope of implementing the regulations.
On Oct. 2, the matter was finally settled. In the “Second Report to the President on Identifying and Reducing Tax Regulatory Burdens,” the Treasury agreed with the concerns raised by family-business owners and their advisers. The report states the proposed regulations will be withdrawn in their entirety.
For now, individuals with estates exceeding the federal estate and gift tax exemptions will need to stay tuned as the Framework or other proposals advance to see if the federal estate tax is repealed. In the meantime, perhaps the retraction of the 2704 proposed regulations and the likelihood of income tax reform building steam will offer some solace.•
• Kristine Bouaichi and Kevin Alerding are partners in Ice Miller’s Trusts and Estates Group. Bouaichi’s primary practice concentrations are in trust and estate planning and administration, wealth succession counseling, and charitable giving. Alerding’s practice focuses on estate planning, business succession planning, estate and trust administration, and litigation involving estates and trusts. The opinions expressed are those of the authors.