Editor's note: Although we don't frequently post articles aimed at advisors with individual clients, we thought the information in this article would still be useful to some readers.

While the GOP tax reform framework clearly calls for a complete repeal of both the estate tax and the generation skipping transfer (GST) tax, the lack of details offered by the plan has created a confusing planning environment for clients—especially high net worth clients.

If one thing is certain, it is that the framework creates an era of uncertainty for clients whose estates would be valued above the estate tax exemption amount (currently $5.49 million per individual).

Despite the fact that the administration has made its support of estate tax repeal clear, it is far from certain what shape future legislation will take and whether an estate tax repeal would even be permanent—meaning that developing flexible strategies to minimize transfer taxes remains just as important as ever.

Unanswered questions and possible answers

The tax reform framework proposal would eliminate the estate tax and the GST tax, but makes no mention of the current gift tax structure.

Under current law, clients may transfer up to $14,000 per year to each donee during life without triggering the gift tax (spouses may elect split gift treatment so that the $14,000 amount is doubled to $28,000 per married couple).

Lifetime gifts above and beyond this annual gift tax exclusion amount are taxed at the 40 percent gift tax rate.

Although the framework does not address the gift tax, it is widely expected that some form of the gift tax will remain in order to prevent income tax evasion (which, for example, could be accomplished by making lifetime gifts of property to family members in lower income tax brackets).

The tax reform framework also makes no mention of the currently existing “step up” in basis that applies to property transferred at death. These rules adjust the basis of property transferred at death so that it equals the fair market value of the property at the date of death (i.e., the property value used for estate tax purposes), which allows heirs to avoid paying capital gains taxes on the appreciation in property value that occurred before they eventually transfer the property.

If the estate tax is eliminated, it is possible that the stepped-up basis provisions would also be eliminated—essentially implementing a carryover basis regime that would apply capital gains tax rules to property transferred at death.

Others predict that a limited step up in basis could be created to shield only property valued under a certain dollar threshold from capital gains taxation.

Potential planning options for transfer tax uncertainty

Because of the uncertainties surrounding potential modifications to the current transfer tax regime, flexibility in planning for both lifetime and testamentary gifts becomes especially important. Flexibility is also key to ensuring that clients are not stuck with an undesirable estate plan in the event that the estate tax is repealed and eventually reinstated by a subsequent administration.

As a result, clients should consider giving independent trustees power to make changes to the allocation of trust assets (for example, a power of substitution to allow the trustee to exchange trust assets for assets of equal value) in response to changes in the estate and GST tax rules that occur over time. This can allow the client to avoid an unfavorable tax outcome if the rules governing tax basis of assets transferred at death are changed.

Powers of appointment can also be useful in allowing for changes in beneficiary designations or trust terms. Similarly, certain states (Delaware, for example) have passed modification rules that can allow for more substantial modifications of irrevocable trusts with the consent of certain parties.

Generally, because of uncertainty in the gift tax area, clients should continue to be advised to avoid large lifetime gifts to avoid attracting substantial gift tax liability.

Maintain flexibility

Although clients may be tempted to rely upon the possibility of complete estate tax repeal, it’s important that they be reminded that the rules governing transfer taxes change frequently (even so-called permanent rules can be repealed) so that maintaining flexibility is key to minimizing transfer tax liability in the long run.

For previous coverage of transfer tax planning strategies in Advisor’s Journal and for in-depth analysis of the federal estate tax, become a subscriber with National Underwriter Advanced Markets. Subscriber questions and comments are always welcome at our blog, AdvisorFYI, at Tax Facts Online or contact the Panel of Experts.

Instant Insights /

GOP tax plan provokes need for estate planning flexibility

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