Estate Tax Elimination Could Cause Problems
In late September the Trump administration released a tax reform framework supported by Congress. The plan includes several of agriculture’s priorities including a repeal of the estate tax, but according to American Farm Bureau Federation’s tax expert, Patricia Wolff, there are a number of unanswered questions. One of those is stepped up basis if the estate tax is eliminated.
“[Congress] is discussing either eliminating step-up in basis or having a capital gains tax at death, similar to the Canadian tax system,” says Paul Neiffer, CPA and principal at CliftonLarsenAllen.
Current law says when a person passes away, their heirs get a step-up in basis on most inherited assets.
For example, Henry and Martha Farmer own a farm operation. Farmland is worth $10 million with a cost basis of $1 million, plus they own farm equipment worth $2 million and have crop on hand worth another $2 million. Henry and Martha pass away in 2018. Their combined estate of $14 million is greater than the $11 million lifetime exemption amount, so the heirs will owe about $1.2 million of estate tax. However, they will inherit a new cost basis in the land of $10 million, the equipment of $2 million (depreciated over 7 years) and $2 million of grain which they can sell for $2 million and owe no taxes.
Eliminating estate tax and stepped up basis would change that. In that case, the heirs of Frank and Martha will not owe any federal estate tax, which will save them $1.2 million of estate tax. However, they no longer get a step-up in basis. If they liquidate all the assets in 2018, they will owe capital gains tax on the land at a rate of about 30% (combined federal and state rates) and will owe about 45% on the sale of the equipment and inventory. Total income tax will be about $4.5 million ($9 million x 30% $4 million x 45%). They saved $1.2 million of estate tax but paid $4.5 million of income tax, a net cost of $3.3 million.
“As you can see, eliminating estate tax can cost many farm families a lot of money if they eliminate step-up in basis or have a capital gains tax at death,” Neiffer says. “Most farmers under current laws will never owe any estate tax, but almost all farm heirs benefit from the step-up in basis.”
Don’t forget to pay attention to state tax laws. Not every state in the U.S. has an additional estate tax, but several states do. Even if federal estate tax is eliminated, states will likely maintain their estate tax policies.
According to Neiffer, it is critical farmers pay attention to their local tax codes in addition to following what’s going on with federal taxes. States that currently have a state estate tax include: Connecticut, Delaware, the District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Tennessee, Vermont and Washington.
Neiffer advises farmers to leave their estate plans alone until tax reform is sorted out.
“There’s no reason to get in a hurry making changes at this point,” he says.
Sara Schafer contributed to this story.