Recently, President Trump put forth a proposal to repeal the federal estate tax. Under existing law, estates with a gross value in excess of $5,490,000 are potentially subject to federal estate tax. A married couple can easily shelter twice that amount (or $10,980,000) from the estate tax.
Chance are, you don’t own assets with a value anywhere near $5,490,000. Chances are, you never will own asset with a value anywhere near $5,490,000. So, the federal estate tax (and the federal gift tax, which also has an exemption amount of $5,490,000) will never affect you.
With that said, for some reason, people worry about the estate tax. They believe that the estate tax will affect them.
In New Jersey, we also have a state estate tax, at least for another three months. The current credit against New Jersey estate tax is $2,000,000. Beginning January 1, 2018, the New Jersey estate tax will be repealed. So, if your estate is in excess of $2,000,000, you only need to hang on for three more months and your estate won’t have to pay a New Jersey estate tax.
Assuming President Trump’s tax plan passes in the near future, there won’t be any estate tax—federal or state. That’s a good thing, at least if you are worth in excess of $2,000,000.
Despite the fact that the estate tax (federal or state) only affects a very small minority of the population, the tax seems to bother a great many people. I’ve never been sure why that is. Perhaps it’s because, on whole, we are optimistic and we believe that someday we’ll be worth millions of dollars and we don’t want the government taxing our future fortune when we die. Perhaps we love rich people and think they should be able to establish dynasties. I’ve never been quite sure what it is that bothers people so much about the estate tax, but I can tell you that it does bother people.
But here’s a real consequence of an estate tax repeal that probably will affect you. Currently, when a person dies, his assets receive a basis equivalent to the date of death value. Typically, this results in a stepped-up basis.
For instance, assume that Mr. Smith purchased 100 shares of stock in IBM in 1965 for $20 a share. Over the course of the next 50 years, Mr. Smith’s IBM stock has split multiple times. He now owns 3,000 shares of IBM stock, trading at $145 a share. Mr. Smith doesn’t remember the price for which he purchased the stock or how many shares he initially purchased.
When Mr. Smith dies, his IBM stock—all 3,000 shares—will receive a stepped-up basis. What this means is that when his family inherits the stock, they will have a basis of $145 in each share of the stock. If the family turns around and sells the stock, there would be no gain on the sale and, therefore, no capital gains tax to pay.
The reason we have basis step up is because of the federal estate tax. Essentially, it’s a trade-off. Estates are potentially subject to paying an estate tax, so in exchange for paying an estate tax (or potentially being subject to a tax), the assets of the decedent receive a stepped-up basis upon death.
If there were no estate tax, there may not be any stepped up basis. From a practical standpoint, what this means is, Donald Trump’s children will not pay a 40% estate tax on his death, but your children will have to pay more in capital gains tax when they sell your stock. The lack of a basis step up will hurt far more people than the estate tax ever would have affected.