By David Herzig
With the first Presidential debate tonight, we are sure (or at least I hope) to hear about various tax plans. I would expect that the estate tax would be a topic of conversation since there is such a sharp contrast between the candidates. The current reporting spins that Donald Trump wants to eliminate the estate tax; while, Hillary Clinton wants to tax the rich through a two-prong increase on the estate tax. I thought it would be useful in advance of the debate to discuss the candidates’ actual estate tax plans. (If there is a PA for Lester Holt looking for some last minute questions for the candidates – scroll to the bottom and steal away no attribution needed!)
Currently, there is an estate (or death) tax. Unfortunately for the fisc, the tax accounts for less than 1 percent of federal revenue. (See, Tax Foundation). What is amazing is that at other points in time, the tax actually raised revenue and effected many estates. The primary reason for the drop in revenues even though overall net worth has increased, is related to the exemption amount available for taxpayers. In 1976, the exemption amount per estate was $60,000 while today it is $5.45 million. (I tackle a lot of these issues in my upcoming University of Southern California Law Review article).
But to truly understand the estate tax, it is necessary to understand how the estate tax interacts with the income, gift and generation-skipping taxes; none of these taxes operates in a vacuum. (For now, I, like both candidates, will ignore the gift and GST taxes). Under IRC 1014, there is an income tax basis step-up or step-down based on the estate tax values of assets passing. Here is a basic example, assume you bought 1,000 shares IBM stock in 1980 for $1 a share. When you died in 2015, it was worth $150 a share. There is $149,000 in built-in income tax gain. Let’s assume further that all your assets were worth less than $5,4300,000 (the 2015 portability amount). Under the estate tax rules, you would have an estate liability that would be off-set by the exemption resulting in no tax due. Your assets that passed to your heirs would then take an income tax basis equal to the value reported on the estate tax return. This would mean that an heir that then sold the IBM stock would have a basis of $150 a share. If the stock were then sold for $150 a share, there would be no additional income tax liability.
Trump’s Estate Tax Plan
According to Mr. Trump’s web site, his estate tax plan is as follows:
“The Trump plan will repeal the death tax, but capital gains held until death will be subject to tax, with the first $10 million tax-free as under current law to exempt 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 will be disallowed.”
Like in 2010 and 1976, Mr. Trump wants to do away with the estate tax. However, unlike prior Republican plans to eliminate the estate tax, Mr. Trump is replacing the estate tax with an income tax. He seems to have shifted to treating death as realization event. Going back to my prior example with the IBM stock, Mr. Trump would tax the stock by reason of the estate tax, but, rather, by reason of the income tax. But, the same resulting zero tax effect since my assumed amount was under $10 million.
There are a series of questions that are unclear from Mr. Trump’s plan:
- Is the $10 million amount the tax amount or the asset amount? For example, does this mean that I have an exemption of the first $66,666,666 in capital gains? ($66,666,666 times the the current 15% rate is a tax liability of $10,000,000). Or does this mean that the first $10,000,000 of capital gain assets are exempt?
- When would the tax be due? I assume that the tax would be due by reason of death. But, this assumption would create a series of collateral consequences. For example, assets would have to be sold in order to raise revenues for the tax. Alternatively, the tax could be deferred until the asset is sold. This approach would create a series of record keeping burdens that might be beyond the capabilities of taxpayers and might actually exacerbate the locked-in effect. But the former approach would still create a “death” tax since death is a triggering event.
- Would 1014 still exist? I would guess that step-up basis would be disallowed since death was a realization event. But, if Mr. Trump wants to “will repeal the death tax,” then it would be necessary to not have death as a realization event and some type of basis modification would be necessary.
- Does the gift tax exist? Many pundits make the assumption that the gift tax is also eliminated, but, his official position does not address this specifically.
- Is Mr. Trump eliminating just private foundations or also public 501(c)(3)’s? For example, the Bill and Melinda Gates Foundation is 501(c)(3) private foundation. Does this mean, that there would be a taxable event if at death Mr. Gates assets were willed to the foundation? I have so many questions. Such as, what if he did the same pre-death? What if Mr. Gates transferred assets to Mr. Buffet’s foundation? What if there was a quid-pro-quo to return those assets to Mr. Gates’ foundation? Why is Mr. Trump concerned with giving to charitable causes? (See, for example, Phil Hackney’s reporting on his ongoing self-dealing with his private foundation).
- Does the generation-skipping tax exist? I am struggling with figuring out how we can have a GST taint on assets. What happens to old GST trusts?
Clinton’s Estate Tax Plan
While Mr. Trump is theoretically (or it is at least scored that way) reducing the burden on wealth taxpayers because of death, Mrs. Clinton is doubling down. Last week, Mrs. Clinton announced that she would raise the top rate to 65%. Under her plan, the 50% rate applies to estates worth over $10 million per person, 55% for estates over $50 million, and 65% for estates exceeding $500 million. Yes, her announcement made headlines, but realistically, it was a modest increase over current levels.
Mrs. Clinton would also repeal what’s known as the step-up in basis. According to her release:
“[S]he will close the “step up in basis” loophole that lets accumulated capital gains go untaxed when assets are passed on to heirs – a loophole where 80% of the benefits go to the top 0.1% of taxpayers earning more than $2 million per year. Her plan will treat bequests as a realization event. It will include exemptions to ensure this change only affects the high-income families who by far benefit the most from this loophole, and protects middle-class families. And it will contain careful protections and flexibility for small and closely-held businesses, farms and homes, and personal property and family heirlooms. She will make strong enforcement against the “private tax system” for the extremely wealthy a priority for her administration.”
There are a series of questions that are unclear from Mrs. Clinton’s plan:
- I have not idea why step-up basis under 1014 should be at issue when there is a tax due at death. If there is an estate tax due by reason of death, why would the assets subject to that estate tax not get a stepped-up or down basis? Her plan would be to tax the accumulated growth of the asset once in the hands of the decedent and once again in the hands of the heir? Why would everyone then not sell all the assets right before death, pay capital gains, then repurchase the assets after death or after a gift?
- Is there a gift tax? Are the rates the same as the estate tax?
- What protections would exist for small business owners? Why do we need protections?
- She also seemingly wants to modify the grantor trust rules. These rules are a crucial component of current estate tax planning. Paying income taxes on assets that are in a trust which is not deemed a secondary gift is a power tool in overall estate reduction. It will be interesting to figure out what she means by modification of grantor trust rules.
- Could people avoid her estate tax by just passing all assets to a private foundation? Mr. Trump seemingly tries to avoid this loophole by having his no private charity backstop.
Each candidate is theoretically advocating for ideals that resonate with its base. For example, Mrs. Clinton wants to “break-up wealth” by taxing the wealthy more at death. While Mr. Trump is preserving the family farm’s by eliminating the “death tax.” What is interesting is that neither candidate is truly moving the needle. Where Mr. Trump seems to protect the wealthy on one hand, he is pulling the rug by creating a capital gains tax. Likewise, Mrs. Clinton is not really breaking up wealth when she is barely raising rates and not attacking the various pre-death planning techniques that mitigate the estate tax. I would love to hear questions asking what is the explicit goal of the candidate. Because looking at the words of the candidates’, I really don’t know.