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GOP Tax Bill Proposes Estate Tax Repeal…Hooray?

On November 2, House Republicans released their tax reform bill, known as the Tax Cuts and Jobs Act (H. R. 1), which proposes to phase out the federal estate tax, a.k.a. the “Death Tax,” over the next five years. Great news, right? That depends on a couple of important factors: (1) the extent of your wealth, and (2) where you live. 

Under current law, each individual is exempt from federal estate tax if his or her gross estate is below $5,490,000 (that amount is indexed for inflation each year, so it will increase to about $5,600,000 in 2018).  Additionally, for married couples, if the estate of the first spouse to die does not consume the full exemption, any unused portion of that exemption can be added on to the surviving spouse’s exemption (assuming the surviving spouse does not remarry). In effect, with proper estate and gift planning, a married couple worth up to approximately $11,000,000 will not incur any federal estate tax.  At nearly 40%, the federal estate tax is a painful bite. 

Considering that less than 1% of Americans are wealthy enough to trigger the federal estate tax, the proposed repeal of the estate tax - while flashy for headlines – does not impact the overwhelming majority of estates. Further, under the new tax proposal, beginning in 2018 the federal estate tax exemption would increase to $10,000,000 per person, and the federal estate tax would be phased out entirely by 2023.  This is a huge deal for individuals with estates valued between $5,490,000 and $10,000,000. For example, under current federal law a person who dies with a $10,000,000 estate would owe about $1,800,000 in federal estate tax. Under the new plan, no federal estate tax would be owed – a boon for some, but not much of a needle-mover for most. Meanwhile, the Senate’s version of the tax bill, released on November 10, proposes doubling the current federal estate tax exemption without any phase out of the estate tax.  The effect would increase the exemption to approximately $11,000,000 for individuals and $22,000,000 for married couples.   

The larger impact will be felt by individuals living in states that still impose estate taxes. A minority of states, including Maryland, still impose a state estate tax in addition to the federal estate tax. Under current Maryland law, a repeal of the federal estate tax will have no effect on existing state estate taxes. 

Like the federal government, however, each estate taxing state allows for an amount that can be excluded from tax. For example, in 2017, the Maryland estate tax exemption for an individual is $3,000,000; in 2018, it will be $4,000,000; and in 2019 it will match the federal exemption level.  Interestingly, the Maryland tax code does not set forth a numerical figure for when the state exemption amount re-couples with the federal exemption in 2019; the statute merely states that in 2019 the federal credit used to determine the Maryland estate tax will be “the applicable exclusion amount corresponding to the applicable unified credit.” 

Thus, if all things remain equal in Maryland, the state exemption will catapult from $4,000,000 in 2018 to between $10,000,000 and $11,000,000, depending on which house’s version of the bill is passed – probably not what a heavily Democratic General Assembly had in mind back in 2014 when it rewrote the statute. Such a drastic jump could cut out a chunk of state revenue that our legislators did not anticipate.  If this portion of the tax bill holds, don’t be surprised to see a bit of scrambling over this issue at the next legislative session. 

The real eye-opener, however, is what the tax bill does not change.  Kept intact are the full step-up in basis rules that apply to assets that pass through an estate.  Under current law, for example, if you die owning very old but highly appreciated stock, which say you acquired in 1965 at $100,000 but is now worth $3,000,000, your estate pays no federal (or Maryland) estate tax.   At your death, the cost basis of those shares of stock is “stepped up” to the date of death value, and your heirs can sell that stock immediately thereafter without incurring any capital gains tax.  Without this step-up basis allowance, the capital gains implications for inherited assets become enormous. 

Many prognosticators surmised that a repeal of the federal estate tax would be offset by the elimination or capping of the of step-up in basis allotment, but both the House bill and the Senate bill left that portion of the tax code untouched.  Unlike the federal estate tax, which affects only a scant few, the step-up in basis rules affect virtually everyone. As the debate continues over tax reform, the repeal of the estate tax will remain a high-profile issue; however, keep a closer eye on whether Congress begins tinkering with the step-up in basis rules as a bargaining chip. 

Strictly from an estate tax perspective, the repeal of the federal estate tax is welcome news for individual taxpayers, but it will affect only a very small portion of the population. For most, how these negotiations impact the current step-up in basis rules will be far more impactful.  Further, on the state level a repeal of the federal estate tax could reignite talks of estate tax adjustments.  For these reasons, effective trust, estate and tax planning remain as important as ever.

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