-By Donovan Thiessen, CPA

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Chances are good that you were one of the 137 million taxpayers who filed an individual income tax return in 2015. In the same year, 11,917 estate tax returns were filed. Sometimes referred to as the “death tax,” this type of tax return is associated with wealthy individuals. By the end of this article (and regardless of your income level) everyone who reads it will understand more about the estate tax, who it affects, and issues with its currently proposed repeal (more on that below).

What Is Estate Tax?

The federal estate tax is a tax on the transfer of assets and property at one’s death. It is applied to decedents with gross estates in excess of $5.49 million for individuals, and $10.98 million for married taxpayers (those are the “Estate Tax Exclusions” for 2017). The asset composition of estates is typically a mix of stocks, real estate, bonds, small businesses, cash, pensions, and other retirement accounts. In 2015, stocks and real estate comprised over half of all asset holdings for estate tax return filers. Deductions from the gross estate are allowed and include funeral expenses, certain charitable contributions, administrative expenses, as well as others. The due date of the estate tax (IRS Form 706) is 9 months from the date of a person’s death. A 6-month extension to file is available if you are unable to file by the ninth month.

The modern estate tax began in 1916, and has had a history of repeals. In 2001, the tax was repealed and the result was a phase out of rates until 2010, when the tax was temporarily eliminated. The tax was re-enacted in 2011 and 2012, with a 35 percent rate on estates exceeding $5 million. It was expected to return to the 2001 rates in 2013, but Congress placed a permanent 40 percent tax on estates exceeding $5 million, with the threshold indexed to inflation.

Historically, estate tax has been a hot political topic, and in recent presidential campaigns, Democrats pushed to increase revenue from estate taxes while Republicans promised to repeal it. In January 2017, House and Senate Republicans introduced two bills—H.R. 631, 115th Cong., 1st Sess. (Jan. 24, 2017) and S. 205, 115th Cong., 1st Sess. (Jan. 24, 2017)—to repeal the estate tax.

What Is The Controversy?

The 11,917 estate tax returns filed in 2015 produced tax revenue of $17 billion…less than 0.6 percent of the total federal revenues that year. (To put that in perspective, the government brought in approximately $3.2 trillion in total revenue.) With individual income taxes representing $1.4 trillion, and payroll taxes accounting for $969 billion, why is so much attention given to such a sliver of proportional tax revenue? Proponents claim that the tax limits the concentration of wealth among dynastic families. According to PolitiFact, in 2011, the 400 wealthiest Americans had more wealth than half of all Americans combined. Since inherited wealth may be a factor in why many Americans who became wealthy have had a better start than the average person, income and wealth inequality in our country (they say) is a reason to continue implementing the estate tax. In addition, if the estate tax is repealed, the lost tax revenue may have to be absorbed by less wealthy taxpayers.

Alternatively, critics argue that it is a type of “double tax,” and that the assets an individual has accumulated in his or her lifetime have already been taxed in annual income tax returns. Critics further argue that the tax goes against U.S. free market principles: We live in a free country where people build businesses from nothing, yet when people pass the fruits of their labors to their heirs, the money gets hit with another hefty tax.

Estate Tax Today

During his presidential campaign, Donald Trump strongly advocated a repeal of the estate tax, and has proposed taxing pre-death appreciation in the capital assets of estates (subject to a $10 million exemption per married couple). It would mean that the person who inherited the asset would not get a step-up in basis to the fair market value at the date of death (which is what currently happens). Instead, the assets would transfer with the decedent’s original basis, and when the assets were later sold—whether on day one or 1,000—the beneficiary would pay a capital gains tax.

Long-term capital gains tax currently ranges from 15-20 percent (which is much better than the current estate tax rate of 40 percent). The problem, though, is determining what the decedent’s original cost basis is. Under the existing rules, stocks, real estate and interest in a business are all determined using current market values that are not difficult to ascertain. However, original basis in assets may be difficult or impossible to attain, resulting in possibly no-cost basis or low-cost basis, and thus higher capital gains.

Another challenge? Necessary tax planning would be automatically shifted to the beneficiary. In the case of an heir not having income or assets that can be used to satisfy a capital gains tax, whether or not the inherited assets would continue to receive a step-up in basis at the date of death would be a major point to consider as we watch the proposed repeal unfold.

The Future Of The Death Tax

Since the federal estate tax has a history of repeal followed by re-enactment, it is prudent to continue estate planning, or begin it from scratch. There are a number of tools that estate-planning attorneys employ to prepare for and mitigate the estate tax.. One such method called “portability” is a tax election that is available to an estate’s executor. Portability was created with the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, and it authorizes the executor to transfer any unused estate tax exclusion amount to the surviving spouse. The surviving spouse may apply this transferred exclusion against his or her estate tax liability. However, a situation may arise where the first spouse to die does not have an estate tax liability (e.g., if their gross estate is $2 million and consists mostly of publicly traded stock) and thus does not meet the filing requirement. If the decedent has $5.49 million – $2 million = $3.49 million in unused estate tax exclusion, that can be passed to the surviving spouse. Furthermore, suppose the surviving spouse lives another 20 years and the same stock grows to $15 million in value by the time of his or her death? The latter spouse could then use his or her exemption plus the $3.49 million. (Note: That could only be completed by making the portability exemption election by filing IRS Form 706 and completing part 6.) The point is, even if you think you may not be required to file a Form 706 estate tax return, and even if the tax is repealed, you may in a position where some inquiry and planning may be beneficial to you and your family.

Making Your Estate Plans Accordingly

Many people wait until it is impracticable to estate plan, and unknowingly place a burden on the heirs, family, and sometimes employees of a company…providing no roadmap of how to navigate without the decedent. (Recall what happened to Prince last year when he unexpectedly died and left behind an estate worth between $100-$300 million, with no estate plan…not even a will.) Although Prince’s situation involved unusually massive wealth, it should be a cautionary tale for those who have yet to make a plan, or who feel that it is not necessary due to the promise of estate tax repeal by our new president.

Donovan Thiessen, CPA has worked with Gerety & Associates, CPAs in Las Vegas, Nev. for 9 years, focusing on trust and estate, and individual and business income taxation. The firm has substantial experience in estate planning and has the ability to handle complex transactions. You may reach Donovan at dthiessen@geretycpa.com. and 702.933.2213.