Financial News & Research
In his 2015 State of the Union address, President Obama laid the groundwork for several significant estate tax changes, which were covered in greater detail in the administration's budget plan for the 2016 fiscal year. Although these proposals are a long way from being enacted, it makes sense to know the key concepts now. Here are several:
Capital gains: When you inherit assets, you currently benefit from a "step-up in basis" to the fair market value (FMV) of the assets on the date of death. Say you receive stock acquired for $5,000 that's worth $15,000 when you inherit it—your basis is $15,000. Sell the shares for that amount and you'll owe nothing in taxes. The $10,000 appreciation in value is tax-free forever.
Under the president's proposal, this "trust fund loophole," so-called because it's often used in conjunction with trusts, would be closed. Instead, you would owe tax on the difference between the original basis and the FMV on the date of death through a "deemed sale." In our example, that would mean a taxable gain of $10,000. The proposal does allow a taxable exclusion on such gains of $100,000 per person ($200,000 for a married couple).
Estate and gift tax exemptions: The president would roll back the estate and gift tax exemptions to 2009 levels. Thus, the $5.43 million exemption in 2015 (inflation-indexed increases have moved it up from an original $5 million) would revert to a $3.5 million exemption, and so would the generation-skipping tax exemption. And whereas the current exemption can be used for a combination of gifts made while you're alive and at your death, the new $3.5-million exemption would apply only to estates. There would be a separate $1-million lifetime exemption for gift taxes. Finally, the top estate tax rate would be raised from 40% to 45%.
Grantor retained annuity trusts: The grantor retained annuity trust (GRAT) has been in the crosshairs of the Obama administration for some time. With this estate planning technique, you create an irrevocable trust for a specified term, funding it with assets, and then receive an annuity paid to you based on IRS-approved interest rates. Eventually, the remaining assets go to your beneficiaries tax-free.
The president's proposals would curtail the tax benefits by (1) requiring a minimum term of 10 years, (2) imposing a minimum remainder interest of 25% of the assets transferred to the trust, or $500,000, whichever is greater, and (3) prohibiting the grantor from participating in a tax-free exchange of assets with the GRAT. These changes effectively would eliminate future GRATs.
Of course, you shouldn't overhaul your estate plan based on these proposals, but do be prepared to update your plan if it looks as if they may become law.