Estate Tax Update: Pay Before You Go?

10:58 am Uncategorized

News reports out of Washington this week suggest that Congress may be considering estate tax legislation with an option that allows Americans to prepay their estate taxes before they die.

According to reports this week from TaxVox and the Wall Street Journal’s Wealth Report, Senator Jon Kyl (R-AZ) is reportedly considering a prepaid estate tax via the creation of “prepayment trusts,” where individuals could transfer assets and pay a 35 percent capital gains tax over the first five years on the accumulated gains of the transferred assets.  The assets’ bases would become their values at the time of transfer.  When the owner dies, the trust goes to the heirs with no estate tax due.

More details from TaxVox:

Because the trust pays tax up front but nothing when the owner dies, revenue gains show up in the 10-year budget window while much of the revenue loss doesn’t occur until the distant future where it doesn’t count under PAYGO rules. The option provides two big tax breaks: there’s no tax on the owner’s basis of assets transferred to the trust and any subsequent profits are taxed at the preferential capital gains tax rates. What’s not to like?

A couple of things. As my colleague Joe Rosenberg points out, the prepayment option would benefit people with liquid assets who could pay the capital gains tax on assets put into the trust. But small businesses and family farms—the groups for whom opponents of the estate tax express greatest concern—would be hard pressed to pay the tax on their illiquid assets. And, as long as the top tax on long-term capital gains is less than 35 percent, the wealthy could realize gains on their assets, pay the gains tax, and transfer the assets tax-free to a prepayment trust. Tax Policy Center colleague Eric Toder notes that the way around that problem is to raise the tax on gains to 35 percent. Doing so would deal with lots of tax problems—but that’s a topic for another day.

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