The federal estate tax is a tax assessed by the federal government on assets that are passed on to a person’s heirs at the time of their death. While numerous proposals to abolish this tax have been introduced by legislators over the years, a repeal seems more likely now that Donald Trump has been elected President. As recently as this last week, Trump reemphasized, to those in attendance at the Conservative Political Action Conference, his desire reduce taxes on the middle class. Although the particulars about how he will accomplish this remain unclear, it is fairly certain that the elimination of the federal estate tax will be part of any tax plan he introduces.
· The Recent History of the Federal Estate Tax
The modern estate tax was established by the Revenue Act of 1916 which created a tax on wealth transferred from an estate to its beneficiaries. Although there have been many changes to this tax since that time, the trends since 1997 when Congress passed the Taxpayer Relief Act have been fairly steady. Over that 20 year period, the estate tax exemption amount has steadily increased from $600,000 in 1997 to $5,490,000 in 2017. During that same time period, the top estate tax rate has decreased from a high of 55% in 1997 to 40% in the current year. An exception to this decline was a blip in the years 2010 to 2012 when the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act reduced it to 35%. It then went back up to 40% in 2013 when the American Taxpayer Relief Act failed to make the reduction permanent.
· The Current Status of the Federal Estate Tax
The estate tax exemption amount for 2017 is $5,490,000, up from $5,450,000 in 2016. Estates above this amount are subject to an estate tax of 18% to 40%, depending on the amount of the overage. However, because the federal estate tax is structured as a unified tax credit instead of allowing the exemption to reduce the amount of the taxable estate, all estates are essentially taxed at the top rate of 40%. This being the case, the 11 lower estate tax brackets are rendered somewhat useless except for calculating the amount of the credit.
· The Use of Gifting to Reduce the Federal Estate Tax
In addition to the annual lifetime exclusion amount there is an annual gift tax exclusion of $14,000 per person per year. This gift exclusion allows each individual to make tax free gifts of $14,000 per year to any number of recipients. Couples can make gifts of $28,000 per year. Over time, such nontaxable gifts can can be used to significantly reduce the amount of a person’s estate while they are still alive. Gifts above these limits are added to the value of a person’s estate at the time of death.
· Replacing the Revenue Generated by the Federal Estate Tax
As might be expected, only a very small percentage of the population is actually affected by the federal estate tax. For example, in 2015, estate tax returns were filed on behalf of less than 0.5 % of all decedents and, of that number, only half had estates valued at more than the exemption limit. However, in spite of the small percentage of estates that actually owe federal estate taxes, abolishing this tax would necessarily result in a loss of federal tax revenue. Because of this, some favor coupling the repeal of the estate tax with some modification to the step-basis that is granted to estates. This pairing would replace some or all of the lost estate tax revenue with capital gains taxes paid by the recipients of estate assets.
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