Don’t Miss The Window

Recently, Treasury has put in motion plans for new rules that will increase federal estate taxes for larger estates, including certain family businesses.  Estate tax matters are mostly a “one-percenter” issue to be sure.  Even in a high net worth advisory the following applies directly to just a handful of individuals.  But to those affected, the next few months may be a valuable estate-planning window.  It’s also, of course, part of a larger policy debate this election season.

Estate Tax and the Election

In 2016 the federal estate tax exemption is $5.45 million per individual—or $10.9 million for a married couple.  Federal estate tax of 40% is applied to amounts over the exemption.  The rates and exemption amounts are set by law, and like any law, changes have to be passed by Congress and signed by the president.

Hillary Clinton and Donald Trump have expressed how they would move to change estate taxes:  Ms. Clinton would reduce the individual exemption to $3.5 million while raising the tax rate to 45%; Mr. Trump wants to eliminate the tax altogether.

For certain high net worth individuals, Ms. Clinton’s tax increase means some thoughtful estate planning is prudent now, particularly those with valuable family businesses or real estate portfolios.  Regardless of their views on estate tax policy itself, these individuals may benefit from accelerating gifting to their heirs in 2016 before lifetime exemptions are lowered and tax rates increased.

Rule Change Coming

On top of these potential law changes are changes in rules that don’t require passage through Congress and have the potential of sticking around regardless of the election.  (They almost certain will with a Democratic win in November.)

Treasury has proposed new rules on valuation discounts of assets transferred to family members.  Currently, if you give your child, say, 20% of a family business or real estate operation with a current total value of $10,000,000, the value assigned to that gift can be assumed to be less than $2,000,000.  That’s because your child would have a minority interest, most likely a passive position in a family partnership she can’t turn around and sell.

Put another way, a business you own and control may have considerable value, but it’s unlikely someone else would be willing to pay a pro rata price for a small, non-control and illiquid piece of your business.

Those minority limitations have allowed estate planners to successfully discount such gifts and get more assets transferred under the estate tax exemptions.  But that looks likely to change, and discounts of even 30% or more may become a thing of the past as Treasury Secretary Jack Lew attempts to close what he calls a gift tax “loophole.”

Treasury has put the rule proposal for comment and plans to roll it out in January. Those affected may want to call their estate and investment advisers now ensure any estate changes can be completed in 2016.