Re: Important Changes To Consider

We hope your New Year has started off well. A couple of tax changes you should know about.

Negating Proposed Regulations to Do Away with Family Discounting. Two bills have been introduced in the new Congress to prevent the Treasury and IRS from finalizing the proposed anti-discounting regulations promulgated last August. We suspect with the new administration taking over, these bills will shortly become law. So discounting family-owned business interests is likely to continue.

Securing Second Income Tax Basis Step-Up. The IRS issued a new revenue procedure last Fall that could affect your estate plan in a positive way. Rev. Proc. 2016-49 (09/27/2016) now eliminates uncertainty over making what is called a "QTIP election" for a marital trust coupled with the new "portability election" that went into effect in 2010. These combined elections could mean your beneficiaries pay less tax.

Prior to Rev. Proc. 2016-49, an earlier revenue procedure would have treated a QTIP election as "null and void" if the election was unnecessary in order to reduce the Federal estate tax liability to zero. Rev. Proc. 2016-49 clarifies the IRS position stating that a QTIP election will not be ignored, so long as the election is made in conjunction with the portability election. This new revenue procedure will benefit couples whose estates are worth less than their combined lifetime basic exclusion amounts. For 2017, that number is $10,980,000 (i.e., $5,490,000 each).

How might this affect you? With this new revenue procedure, it is now possible to take advantage of a second step-up in income tax basis on death of the surviving spouse without sacrificing the deceased spouse's basic exclusion amount. Depending on the size of your estate, it may be advisable to adopt an estate plan that passes the entire estate of the first spouse to die to a QTIP trust for the benefit of the surviving spouse, even if the decedent's taxable estate does not exceed his or her lifetime basic exclusion amount. The deceased spouse's unused exclusion amount ("DSUEA") may be transferred to the surviving spouse, if portability is elected, so it will not be wasted by making the QTIP election. Again, the emphasis to this planning opportunity is an additional income tax basis step-up at death of the surviving spouse, meaning your beneficiaries will pay less income tax when they sell any inherited assets.

To illustrate, a couple owns assets equally with a fair market value ("FMV") of $7,000,000 and an income tax basis of $4,000,000. Assume the first spouse dies in 2017 when the basic exclusion amount is $5,490,000. Under an estate plan designed with Rev. Proc. 2016-49 in mind, upon death of the first spouse, $3,500,000 passes into a marital trust for which a QTIP election is made in conjunction with a portability election. No estate tax is owing due to the unlimited marital deduction so the DSUEA passes to the surviving spouse. The basis of the assets in the QTIP trust is now $3,500,000, the FMV of the decedent's assets on date of death. The surviving spouse still owns assets individually having a basis of $2,000,000. Together with the QTIP assets, the aggregate tax basis is $5,500,000.

Suppose on death of the surviving spouse the assets owned by the survivor and the QTIP trust have appreciated in value to $10,000,000. What happens then?

The income tax basis in the assets owned individually by the surviving spouse and by the QTIP trust get stepped-up to $10,000,000, the assets' FMV on the survivor's date of death. That is because the QTIP trust assets are included in the surviving spouse's estate. However, by making the original QTIP and portability elections per Rev. Proc. 2016-49, no estate tax is owed on death of the surviving spouse because his or her estate tax applicable exclusion amount, consisting of the first spouse's DSUEA of $5,490,000, plus whatever the survivor's lifetime basic exclusion amount is in year of death after being adjusted for inflation, completely shelters the $10,000,000 from estate tax. The benefit Rev. Proc. 2016-49 brings to the estate plan is a significant savings in capital gains tax on the $10,000,000. Absent this revenue procedure and the second basis step-up it affords, the tax cost to the heirs upon later sale of the inherited assets would be $1,260,000 (i.e., [$10,000,000 FMV - $5,500,000 basis] x 28% capital gains rate).

While the Republicans have often spoken of repealing the estate and generation-skipping transfer tax systems, and while they have an historic opportunity to do so in the next two years, political realities (i.e., convincing the public that repeal is not a give-away to the wealthy) may inhibit them from actually achieving their goal. Even if they decide to spend the political capital and move forward with repeal, repeal may not be permanent; it may only last for 10 years. To get any tax law changes passed through Congress, it is being reported that that will occur under a legislative process known as "reconciliation," which only has a 10-year window. Think Bush tax cuts! All we can say is stay tuned. Meanwhile, taking advantage of Rev. Proc. 2016-49 should not be overlooked.