How to Plan for Upcoming Estate and Gift Tax Changes

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The estate tax is a tax on your right to transfer property at your death. It is assessed at the time of your death and consists of an accounting of everything that you own or have certain interests in as of the date of death.

In addition, a gift, as defined by the IRS, is “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.”

A transfer takes place either during lifetime when you make gifts to others or upon your death when property is left to your heirs. Estate and gift tax transfers are measured by the fair market value of property on the date of the transfer.

The federal gift tax is the responsibility of the person who gives a gift (i.e., the donor), and the amount of tax due is based on the value of their gift. The person who receives a gift (i.e., the donee) is generally not responsible for paying the gift tax. However, if the donor does not pay the gift tax, the donee may have to pay the tax instead.

The estate and gift tax exemption is $5,490,000 for 2017 (up from $5,450,000 in 2016). Under current law, when a family member dies, if their total assets are valued above $5,490,000 (or $10,980,000 per couple), their estate can be taxed at a federal rate of 40%, which can be financially devastating for a family, particularly if the estate does not have sufficient liquid assets to pay the tax. Similarly, cumulative gifts of money or property, during one’s lifetime, that exceeds the $5,490,000 threshold, is subject to a 40% federal tax as well. In addition, some states have their own transfer tax regime with exemptions that are much smaller than the federal exemption.

Each donor has a lifetime exemption. This refers to the total amount that an individual can give away during their entire lifetime. If the gift exceeds the $14,000 annual threshold, it must be reported as a taxable gift on Form 709 which must be filed by April 15 of the year after the gift was made; however, that doesn’t necessarily mean that they will have to pay the gift tax. Instead, they can apply the gift towards their lifetime exclusion from the Federal estate tax.

The “basic exclusion” (also known as the “unified credit”) represents both the lifetime gift tax exemption and the estate tax exclusion, signified as a total amount of $5,490,000. The current law allows individuals to give away up to $5,490,000 over their lifetime without having to pay gift or estate taxes.

If a first-to-die spouse has not fully used the estate tax exclusion, the unused portion, called the “Deceased Spousal Unused Exclusion Amount,” or “DSUE amount,” can be transferred or “ported” to the surviving spouse. Thereafter, for both gift and estate tax purposes, the surviving spouse’s exclusion is the sum of (i) his/her own exclusion, plus (ii) the first-to-die’s ported DSUE amount.

A primary goal of estate planning is to therefore reduce the size of one’s estate to mitigate the enormous estate tax burden. One common estate planning technique is to transfer assets, or interests, with valuation discounts applied, to family members.

What are Valuation Discounts?

A valuation discount is a reduction in the value of an asset due to certain restrictions in the ownership of the asset, such as an asset’s lack of marketability or the fact that the individual owns a minority interest in the asset. When you transfer an asset out of your estate (e.g. your 10% ownership in a company) to another individual, usually a family member, the Treasury allows for a discount on its value (which can be 40% or more in some cases). The reduction in value can result in significant estate and gift tax savings by reducing the value of the transfer.

However, this common technique may be altered by proposed Treasury regulations whereby they now aim to eliminate almost all minority discounts for closely held entities.

What is changing and why?

The proposed changes are called the “2704 Regulations.” The new changes include reduced valuation discounts, or possibly eliminating the discounts altogether. Although the valuation discounts, in many cases, are used legitimately, too frequent use of valuation discounts triggered IRS scrutiny and accusations of abuse.

If the proposed regulations become final, taxpayers will lose a substantial estate planning technique and therefore the tax cost associated with transferring interests in family-owned entities will drastically increase.

When could this change take place?

It is difficult to predict what changes will be included in the final regulations, or when they will be finalized. The Treasury hearing on the proposed changes took place on December 1, 2016 and drew the biggest crowd ever to a Treasury public hearing. An overwhelming majority of public comments were against the proposed changes, citing the potentially detrimental effects to family-owned businesses. The proposed new rules have drawn 9,477 comments so far and that number continues to climb.

The Treasury will take all of the comments into consideration when it is deciding whether to approve the new regulations. The timing of when the proposed 2704 Regulations will be finalized, or whether they are finalized at all, may be impacted by the transition from the Obama administration to the new Trump administration in January 2017, including the possibility of the repeal of the estate tax under a Trump administration.

President Donald Trump had identified tax reform as a priority of his new administration, and he made the repeal of the estate tax one of his core campaign promises. Under his proposed tax plan, the estate tax would be repealed, but capital gains on property held until death and valued over $10 million would be subject to tax, with an exemption for small businesses and family farms. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives would be disallowed. Whether his tax reform plans are seen through is still unknown.

How to plan?

The time is now to meet with estate and trust planning professionals to design a plan that maximizes tax savings opportunities for you or your organization. Having a plan in place means you and your assets are ready for the future.

If you are a business owner:

  • If you are thinking of transferring your business to your children, acting sooner rather than later means you can take advantage of valuation discounts and related wealth strategies that may soon disappear.

If you are an individual considering estate planning:

  • If you were thinking about getting your estate planning underway, let this be the fire under your feet. There is only a short period of time between now and when the new regulations may go into effect. Most estate planning processes take anywhere from 30 – 60 days.

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

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