There has been a lot of talk about the myriad of tax law changes with the passage of the “Tax Cuts and Jobs Act” (TCJA), but let’s not forget about the estate tax. One of the biggest assets for an entrepreneur is their business and the Estate and Gift tax can have a big impact on your heirs.
Losing the proverbial “family farm” was a reality for many when they owed tax on 45% or more on the fair market value of a business within 9 months of the death of a loved one. The family would oftentimes have to sell the business at a major discount just to come up with the money for the tax bill.
Although the House of Representatives’ version of the recent tax bill had included language to repeal the federal estate tax in its entirety by the year 2025, the final version that was signed by President Trump did not repeal the estate tax.
The New Law. Instead, the TCJA doubled the estate tax exemption from $5.49 Million to $11.2 Million (taking into account inflation). Of course, the average American’s net worth is far less than this and maybe that’s why no one is talking about it, but I thought it was at least worth a short article to set forth the facts.
This means that even less Americans will pay federal estate tax. Thus, if an individual is worth less than $11.2 Million, or a married couple less than $22.4 Million, they will pay no estate tax at all. If you think about it in those terms, a VERY small fraction of America (less than 1%) is going to ever pay federal estate tax.
Will it last? For all of you mega wealthy out there, this “win” is short-lived as this increased exemption will only last until the year 2025. If Congress does not make any other changes in this regard by 2025, the estate exemption will revert back to what it was in 2017 which is $5.49M exemption for individuals (as adjusted by inflation) and $10.9M for married couples (through portability).
What’s the rate on all of this wealth over the exemption amount? A hefty 40%.
But what about State Estate tax?
That’s right…no play on words. Keep in mind that a few states assess estate tax at the state level (Washington, Oregon, Hawaii, Minnesota, Illinois, New York, Vermont, Massachusetts, Maryland, Rhode Island, and Connecticut). Of these states, a few of them set their estate exemption regardless of federal estate tax exemption. Thus, in the states that don’t ‘conform’ to federal law, the new TCJA will have no bearing or effect at all at the state level.
On the other hand, a few of these states use the SAME estate tax exemption figure as the federal, in other words ‘conform’. For example, Hawaii has a state estate tax exemption that mirrors the federal estate tax exemption. So for a Hawaii resident, this new change in federal law ALSO has a huge positive impact at the state level.
Oh…and by the way, for the sake of clarity, estate tax (at both the state and federal level) is a tax on the estate, whereas a few states (Nebraska, Iowa, Kentucky, Pennsylvania) assess a tax known as an “inheritance” tax which a tax paid by the recipient, but that’s a topic for another day.
Now for the Gift Tax: The ‘sister’ to the Estate tax
It’s important to remember that this new tax law only pertains to federal estate tax. It’s important to note that the lifetime gift tax exemption has also been doubled. As you may know, the gift tax was enacted to prevent taxpayers from avoiding estate tax by simply gifting their estate during their lifetime.
So it would make sense that as the estate tax exemption has been doubled, so has the gift tax exemption. This means you can give your assets away during your lifetime and so long the cumulative value of the gift(s) does not exceed $11.2M, generally, no gift tax would be imposed. I’ll give you my address if you are stuffing an envelope with a big check.
Finally, if the Gift Tax is the sister to Estate Tax, then tax law regarding Stepped Up Basis is its 1st cousin. Thus, it’s also very important to you and me and should be noted that the new tax law retains the stepped up basis in property received from an estate.
This is actually a law that really does affect all the ‘commoner’, or middle-income American. If you didn’t know the concept already, when you receive property through an inheritance (someone’s Will, Trust, etc.), the basis in that property “steps up”, meaning it increases in value from whatever the actual basis was in the property to the Fair Market Value (FMV) of the property at the time of death. For you as the recipient of the property, this is a HUGE tax benefit!
For example, if Aunt Bertha bought an investment property in 1960 for $25,000 and it’s now worth $150,000, that’s a huge gain and tax liability if the property were sold by Aunt Bertha before her death. Moreover, if Aunt gifts you the property, or puts your name on the title, you get a carried over basis and will pay the same tax.
Result. But if YOU inherit Aunt Bertha’s home upon her death, and you want to sell it a couple years later for $200,000, your ‘basis’ would $150,000 (the FMV upon her death), instead of $25,000. Thus, you only pay tax on $50,000 and you get a big tax benefit selling it after you inherit the property.
Ultimately, for most middle-class Americans, it’s important to remember that you alway’s liked your 1st cousin and didn’t mind seeing them once and a while at a family reunion. So just because you aren’t part of the 1% wealthiest people in America and could care less about the estate tax, YOU DO care about the concept of “Stepped Up Basis”. Maybe you should have sent a Christmas Card to your cousin this last December after all.
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Mark J. Kohler is a CPA, Attorney, co-host of the Radio Show “Refresh Your Wealth” and author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.