The Presidential Candidates, the Federal Estate Tax, and the Capital Gains Income Tax
Posted on: November 8th, 2016
By Mary Merrell Bailey, Esq. CPA MBA MSTax MSAccounting
Tonight, we should know who will be our next president. While Congress passes tax legislation, the president shapes policy. What plans does Donald Trump have for the estate tax versus Hillary Clinton? How do the plans differ compared to the current rules?
Estate Tax Now
The estate tax is one of three federal transfer taxes – an excise tax, separate from and in addition to the income tax – levied on the privilege of transferring wealth. If you transfer wealth during your life, the transfer is subject to the gift tax. If you transfer wealth at your death, the transfer is subject to the gift tax. If you transfer wealth to someone who is a “grand” to you by blood or marriage– a grandchild or grandniece, for example – or someone who is not related to you but who is 37 ½ years or more younger than you, then the transfer is taxed twice, once with the generation skipping transfer tax plus either the gift tax or estate tax. Each U.S. citizen or green-card holder has an exemption amount of $5.45M in 2016 – married couples can combine their amounts for a total of $10.9M – with every dollar transferred in excess of that amount (with some exceptions) taxed at 40%.
Capital Gains Income Tax and Inherited Assets Now
Inherited assets get a step-up in basis to Fair Market Value (FMV), which reduces potential capital gains income tax when the asset later is sold. This means that assets that were already subject to the estate tax are not taxed again by being subject to the capital gains income tax.
For example, if my Aunt Dorothy buys a piece of real estate for $100, her basis in that property is $100. If Aunt Dorothy sells that piece of real estate while she is alive for its FMV of $1,000, she would pay capital gains income tax on the $900 realized capital gain. If Aunt Dorothy gifts me that piece of real estate while she is alive, her basis of $100 will “carryover” to me. If I then sell the real property for $1,000, I will pay the capital gains income tax on the $900 realized capital gain.
If, however, Aunt Dorothy dies owning the piece of real estate, the property will be included in the value of her estate and subject to the estate tax. If she bequeaths the real estate to me at her death, I will inherit the property with a “stepped-up” basis of FMV of $1,000. If I then sell the real property for $1,000, I will pay zero capital gains income tax, because $1,000 FMV minus $1,000 stepped-up basis = zero realized capital gain.
How does Hillary Clinton Plan to Change the Transfer Taxes?
If Hillary Clinton is our elected president, she plans to reduce the amount of assets that each person can transfer for free at death to $3.5M, and $1M for gifts during life. (Differentiating the amount that can be passed for free based on the timing of the transfer dramatically would increase the compliance costs of record-keeping and accounting.) In addition, she wants to increase the tax rates charged on the transfers to 45% for estates worth $3.5M to $10M, 50% for estates worth $10M to $50M, 55% for estates worth $50M to $500M, and 65% for estates worth > $500M.
Most radically, Hillary Clinton’s plan includes eliminating the step-up in basis for inherited assets, which would subject the inherited assets to both the estate tax and the capital gains income tax. Potentially, then, the same asset could be taxed at 65% for the estate tax plus 23.8% for the capital gains income tax, for a combined total of 88.8% tax.
How does Donald Trump Plan to Change the Transfer Taxes?
If Donald Trump is our elected president, he plans to repeal the estate tax. He considers it a double-tax, because the assets, when they originally were earned, were subject to the income tax.
What to Expect
Regardless of the outcome of the presidential election, significant tax legislation change would require Congress to take action. The president can promote a platform, but does not make laws. Changes to the transfer taxes because of a new president will not happen in 2016, and likely are not on the first page of priorities to occur in 2017.
Once the election is over, we encourage our clients to give thought to their potential tax exposure based on the incoming president’s platform. Pay attention to our Cookies & Counsel™ topics and our newsletters to keep informed. As changes to the laws arise, we will be happy to sit down with you to discuss various potential scenarios and to map out a preliminary estate planning strategy. Feel free to call our office at 407-622-1900 to arrange an appointment.