There’s a lot of chatter about estate tax reform and how it might work. By the time you read this you might have a little more clarity on how it will look; however, this is a good time to examine the potential effects.
Q: Will the estate tax be repealed?
Today, farm couples worth up to about $11 million don’t owe federal taxes. However, both President Donald Trump and the House Republicans want to repeal the estate tax. The Democrats will oppose this repeal and if the Republicans are not able to overcome their resistance, they will be forced to pass this as a part of the budget process. Under these procedures, the Republicans will be able to pass it with a simple majority; however, the law will be in effect for only 10 years and then revert back to current law at that time.
Q: What about the gift tax?
Both Trump and the House are completely silent on the status of a gift tax. It is likely some type of gift tax will remain (likely to prevent donors from transferring assets to states with no state income tax, selling the assets and then transferring them back with no state income tax being paid). However, we don’t know if the lifetime or annual exclusion amount will change.
With the retention of a gift tax, it might be difficult for wealthier farmers to transfer substantial values before death. In these cases, the only benefit from the repeal of the estate tax is if you pass away during this 10-year period. This might be good for your heirs but not good for you.
Q: Could a step-up in basis at death be eliminated?
Trump has proposed the step-up at death be at least partially eliminated. The step-up in basis means your cost basis during life becomes irrelevant when your heirs receive your assets. They are able to adjust their “tax” cost basis to the value of farmland and other assets at the time of your death. This can be valuable to your heirs.
For example, assume Farmer A passes away and the farmland he paid $500,000 for 50 years ago is now worth $20 million. His heirs get to “step up” the cost basis to $20 million and can sell it for $20 million and owe no capital gains taxes. Under the president’s proposal, the heirs might be only able to step it up to $10 million (or some other number) and will owe capital gains taxes on $10 million (costing them about $2 million of capital gains tax).
I think most farmers with equipment and crop inventories would appreciate a step-up for their heirs. The step-up in land values only helps if the heirs plan on selling the assets.
Q: How could capital gains tax at death change?
This might become a way for lawmakers to pay for repeal of the estate tax, and it could play out similar to the Canadian system where assets are deemed to be “sold” at death. This would likely work by reporting all of the assets you own at death on your final income tax return. In Canada, even life insurance can be subject to income tax at death. This gain would be deferred if it passed to your surviving spouse; however, they would owe the tax as they sell assets.
I think most farmers would prefer keeping an estate tax rather than owing capital gains tax at death and no step-up in basis. With planning and time, farmers can usually reduce or eliminate the estate tax. A capital gains tax owed at death would be much more difficult to eliminate.
As you can see, there’s a lot of flux in estate tax reform at press time. We will keep you posted, as major changes are ahead. Some changes could benefit farmers, while others hold potentially negative outcomes.
My recommendation is for farmers to avoid any major estate tax planning until we know how tax reform might affect it. Otherwise your actions might cost you a substantial amount.