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Be Careful What You Wish For – US Estate Tax Reform

A variety of tax reform proposals are currently being considered by Congress and the Trump administration, one of which is the repeal of the US Estate Tax.

With a life-time exclusion amount of currently $5.5 million, a married couple (both of whom are US citizens) can pass almost $11 million to their family and friends without incurring an Estate Tax.  (It is estimated that the current Estate Tax impacts only 0.2% of the US estates.)

Under current rules property passed at death receives a “step-up” in tax basis for purposes of determining future capital gains on the sale of the property.  For example, if a taxpayer buys an asset for $100 and then later sells the property for $500 the taxpayer will have a capital gain of $400.  houserevHowever, if the property passes on the death of the taxpayer, the tax basis for the recipient is increased to the value of the property at the date of death of the decedent.  For example, taxpayer A buys property for $100.  At death, the value of the property is $450.  Taxpayer B, inherits the property and later sells the property for $500.  As taxpayer B’s basis was stepped up to $450, the gain on the sale is only $50.

Estate Tax Repealed?

If the Estate Tax is repealed it is more than likely that the basis “step up” at death will be removed and be replaced by what is called “carry-over” basis.  So, under the facts above, taxpayer B will inherit the property but with a tax basis of $100 i.e. the original basis “carries over”.  Thus, when taxpayer B sells the property there will be a taxable gain of $400.

Although the repeal of the Estate Tax may well be welcome, its repeal may, in fact, ultimately result in more tax being paid to the US government than is currently paid under the Estate Tax system.

And for some, the result may be even worse.  There is currently a proposed bill in California that, if enacted, would impose a California Estate Tax equal to the repealed US Estate Tax.  Were this to happen, taxpayers in California could face an Estate Tax imposed by the state, and an increase in the federal capital gains tax as described above.

Much is up in the air—will the Federal government repeal the Estate Tax?  If it does, will California impose a tax equal to the repealed federal Estate Tax?  And if the California bill becomes law, will other states follow suit?

 

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