Subject: Gordon Schaller and Eric Bardwell on the Double Whammy - Federal Estate Tax Repeal Could Substantially Increase Tax for California Residents With all of the talk about potential repeal of the federal estate tax, many people have decided to postpone further estate planning, hoping that the repeal will occur. However, Californians should hold out no such hope. On February 21, 2017, California State Senator Scott Wiener announced a ballot measure, Senate Bill 726, that would create a California estate tax if the federal estate tax is repealed, equal to the federal estate tax that would have been paid by a California resident decedent. On March 23, 2017, Senator Wiener amended Senate Bill 726 to call for a special election of California voters and to specifically modify the California Revenue and Taxation Code to implement his proposal. This "springing" estate tax is meant to recapture those funds for California s schools, healthcare, roads and public transportation, according to Senator Wiener. California voters in 1982 voted to prohibit any state inheritance or estate tax by approving Propositions 5 and 6 by votes of 61.8% and 64.4%, respectively. Senator Wiener's proposed measure would repeal that ban and institute a California estate and gift tax essentially identical to Subtitle B of the current Internal Revenue Code, effective January 1, 2019. Although this will require voter approval, unfortunately for wealthy Californians history shows that the majority of voters favor increased tax on the perceived rich. In 2012, 55.4% of California voters approved Proposition 30, a "temporary" increase in the top marginal tax rate for the wealthiest Californians to as high as 13.3% to help fund education and vital services. In 2016, 63.3% of California voters extended those higher rates by passing Proposition 55.
It appears, therefore, there is a realistic possibility that a ballot measure to merely "capture" the estate tax that California s wealthiest residents would have paid to the federal government may pass. This begs the question - if California is willing to resurrect its estate tax, why would other states not follow suit? LISI has provided members with significant commentary on the potential cost of delaying planning: Estate Planning Newsletter #2489, Jonathan G. Blattmachr and Douglas J. Blattmachr: Even Without Estate Tax the Right Answer Is Still the Same, Put It All in Trust Estate Planning Newsletter #2491, Martin Shenkman and Jonathan Blattmachr: Not So Hard to Figure: The Critical Importance of Current Continuous Estate Planning Estate Planning Newsletter #2526, Robert W. Finnegan: Planning in Uncertain Times Part II: The Cost of Delay Now, Gordon Schaller and Eric Bardwell provide members with additional perspective on this important topic and describe how some states may react to repeal of the federal estate tax. Gordon A. Schaller is managing partner of the Orange County office of Jeffer Mangels Butler & Mitchell LLP. Gordon focuses his practice on tax, estate planning, charitable planning, wealth management services, business succession planning, life insurance planning and trust and estate litigation. He represents high net worth individuals and business owners as well as numerous public and private charitable organizations. Gordon is a fellow of the American College of Trust and Estate Counsel and a frequent writer and speaker on life insurance, estate and income tax planning, and charitable planning. Eric Bardwell is a tax and estate planning attorney in the Orange County office of Jeffer Mangels Butler & Mitchell LLP. Eric's practice focuses on all aspects of wealth transfer planning, including estate planning, income tax planning, charitable planning, business succession planning and post-death administration. Eric is designated as a Certified
Specialist in Estate Planning, Trust & Probate law by the State Bar of California, Board of Legal Specialization. Here is their commentary: EXECUTIVE SUMMARY: With all of the talk about potential repeal of the federal estate tax, many people have decided to postpone further estate planning, hoping that the repeal will occur. However, Californians should hold out no such hope. On February 21, 2017, California State Senator Scott Wiener announced a ballot measure, Senate Bill 726, that would create a California estate tax if the federal estate tax is repealed, equal to the federal estate tax that would have been paid by a California resident decedent. On March 23, 2017, Senator Wiener amended Senate Bill 726 to call for a special election of California voters and to specifically modify the California Revenue and Taxation Code to implement his proposal. This "springing" estate tax is meant to recapture those funds for California s schools, healthcare, roads and public transportation, according to Senator Wiener. California voters in 1982 voted to prohibit any state inheritance or estate tax by approving Propositions 5 and 6 by votes of 61.8% and 64.4%, respectively. Senator Wiener's proposed measure would repeal that ban and institute a California estate and gift tax essentially identical to Subtitle B of the current Internal Revenue Code, effective January 1, 2019. Although this will require voter approval, unfortunately for wealthy Californians history shows that the majority of voters favor increased tax on the perceived rich. In 2012, 55.4% of California voters approved Proposition 30, a "temporary" increase in the top marginal tax rate for the wealthiest Californians to as high as 13.3% to help fund education and vital services. In 2016, 63.3% of California voters extended those higher rates by passing Proposition 55.
It appears, therefore, there is a realistic possibility that a ballot measure to merely "capture" the estate tax that California s wealthiest residents would have paid to the federal government may pass. This begs the question - if California is willing to resurrect its estate tax, why would other states not follow suit? COMMENT: Prior to January 1, 2005, many states collected a state estate tax called a "pick-up tax". The pick-up tax was based on the state estate tax credit which was allowable on a decedent's federal estate tax return. 1 Put simply, it was a revenue sharing agreement between the Department of the Treasury and state taxing authorities. The pick-up tax neither increased nor decreased a decedent's overall federal estate tax. Instead, it provided states with the ability to collect revenue from decedents without having to enact a separate state level estate tax by apportioning the federal estate tax revenue between the Department of the Treasury and state taxing authorities. That all changed with the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001, which called for the gradual phase out of the state estate tax credit and the availability of a deduction against federal estate taxes for state estates taxes paid. 2 In response to the repeal of the state estate tax credit, many states have enacted their own state level estate tax to continue generating revenue from decedents. 3 A "double whammy" from new state estate taxes could occur if, as many believe, the cost of repeal of the federal estate tax will be that the income tax basis of a decedent s assets will not be stepped up at death as currently provided. Thus, income taxes on the sale of appreciated assets could replace estate taxes on the value of those assets at death except in California, and other states with a state level estate or inheritance tax, where both taxes could remain a "double whammy." Under current law, although a decedent's estate may be subject to estate tax, in most cases the assets included in the decedent's estate receive a step-up (or step-down) in basis equal to their date of death fair market value. 4 This means that when you inherit Apple stock from your mother that she paid $1 per share for, valued at $140 per share as of
your mother's death, it is treated as though you acquired the Apple stock for $140 per share. If you later sell the stock for $145 per share, your taxable gain is only $5 per share. However, if the ability to obtain a stepup in basis on assets received from a decedent is eliminated, your taxable gain could instead be $144 per share - the same gain your mother would have had if she sold the stock during her lifetime. Assume, for example, a single California decedent left an estate valued at $20 million which passes to his sole child. The decedent's aggregate income tax basis in those assets at the time of his death was $10 million. Under current law 5, $5.49 million of the decedent's estate is exempt from estate tax, and the remaining $14.51 million is taxed at 40%, resulting in a net inheritance to the child of $14,196,000 ($20,000,000 - $5,804,000). The child could sell the inherited assets the same day he received them and pay no federal or California income taxes. Senator Wiener's proposal would result in the same estate tax (although it would be payable to California, not the Department of the Treasury), but if the ability to obtain a basis step-up is eliminated it would also cause the child to incur an income tax on the inherited assets upon disposition, if not earlier. 6 If the child decided to liquidate his inheritance the day after his father died, he could be subject to a capital gains tax equal to 37.1% of the gain, or an additional $3,710,000 of tax. 7 This combination of California estate tax and the loss of a step-up in basis could result in some Californians being subject to a total tax burden of up to 77.1%. California residents, and those in other states who collected a pick-up tax prior to January 1, 2005, should not postpone estate planning in the "false hope" that there will not be an estate tax in the future. Waiting could also result in losing the ability to make lifetime transfers of interests in family entities if the proposed regulations under Internal Revenue Code Section 2704(b) are finalized. 8 Thus, "hope is not a strategy." 9 In the event the federal estate tax is repealed, it may end up costing you more to pass assets to your heirs than ever before.
HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! Gordon Schaller Eric Bardwell CITE AS: LISI Estate Planning Newsletter #2531 (April 6, 2017) at http://www.leimbergservices.com 2017, Gordon A. Schaller and Eric R. Bardwell Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. CITATIONS: 1 IRC 2011, repealed by Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. No. 107-16, 532. 2 Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. No. 107-16, 532. 3 As of the date of this writing, 18 states and the District of Columbia collect a state estate tax. Ashlea Ebeling, Forbes, Where Not To Die In 2017 (2017), https://www.forbes.com/sites/ashleaebeling/2016/10/25/where-notto-die-in-2017/#1f8079751e37. 4 IRC Section 1014. 5 IRC Section 2010.
6 Some commentators believe that income tax may be triggered automatically at the time of the decedent's death, rather than at a later disposition of the assets. 7 The highest federal capital gains rate is currently 20%, the highest California income tax rate is currently 13.3%, and the Net Investment Income Tax is equal to 3.8%. Combined, this results in a 37.1% long term capital gains tax rate for Californians. It is assumed that the Executor of the decedent's estate would have to liquidate assets, thus incurring income tax, in order to pay the estate tax. 8 Prop. Treas. Reg. Sections 25.2704-1, 2, 3 and 4, 81 Fed. Reg. 150, 51413 (Aug. 4, 2016). 9 James Cameron; also often attributed to Vince Lombardi.