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TAX ALERT 2016‐5
DECEMBER 2016
The 2016 Election: Tax Changes Expected
INTRODUCTION
The election of Donald Trump as President is expected to lead to significant tax law changes. The tax changes
may come in two parts: (1) from the repeal of the Affordable Care Act (ObamaCare) and its related taxes and (2)
from comprehensive tax reform. Since Republicans will also have majorities 1 in both the House and Senate, it is
anticipated that such changes could be undertaken without the need for bipartisan support. It is likely that the
Affordable Care Act, and its taxes, could be repealed in early 2017 and result in an immediate tax cut for dividends,
capital gains and high‐income earners. It is more time consuming to enact comprehensive tax reform and such
efforts may not result in a tax bill until midsummer
or the fall, which could push the
effective date of broad‐based tax changes into
2018. Although it is not yet known exactly
what the changes will be or when they would
be effective, we are issuing this Tax Alert to
inform you of changes that are anticipated,
based on proposals made during the campaign
by both President‐elect Trump and the House
Republicans. We also discuss how these
changes may impact your planning, both
currently and in the future. When we have
more specifics, we expect to issue another Tax
Alert.
INCOME TAX
Current law. Ordinary income can be subject
to rates as high as 39.6%, and capital gain can
be subject to rates as high as 20%. In both
cases, an additional 3.8% surtax might apply.
Certain itemized deductions are “phased out”
under the so‐called “Pease limitation” when
Individual
Tax Rates
Top Capital
Gains/Dividend
Tax Rate
Itemized
Deductions
AMT
Investment
Surtax
Estate Tax
Current Law*
10, 15, 25, 28,
33, 35, 39.6%
20%
(plus 3.8%
surtax)
3% of itemized
deductions are
lost when adj.
gross income
exceeds
$313,800
($261,500 if
single)
Parallel tax
calculation
Trump Plan
House GOP
Plan
12, 25, 33% 12, 25, 33%
20% 16.5%
Limited to
$200,000
(couples);
$100,000
(singles)
Eliminates
Eliminates
except for
charitable and
(likely capped
and modified)
mortgage
interest
Eliminates
3.8% Eliminates Eliminates
40% rate,
$5,490,000
exemption
*Inflation adjusted amounts for 2017
Eliminates
(capital gain at
death subject to
$10 million
exemption)
Eliminates
adjusted gross income reaches certain thresholds. The Alternative Minimum Tax can result in additional tax
liability. The income from so‐called “carried interests” is taxed as capital gain.
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In the House of Representatives, a simple majority is sufficient to pass legislation. It is more complicated in the Senate,
where 60 votes (a super majority) are required to avoid a filibuster. Republicans have a simple majority, but not a super
majority, in the Senate. However, there is a budget procedure known as Reconciliation, which allows certain legislation to
be passed without filibuster. Accordingly, it would appear that Republicans could pass tax legislation in the Senate with just
a simple majority.
TAX ALERT 2016‐5: THE 2016 ELECTION: TAX CHANGES EXPECTED
Proposals. Both President‐elect Trump and the House Republicans would lower the top tax rate for ordinary
income to 33%. President‐elect Trump would maintain the top rate on capital gains at 20%, though it might be
applicable at a lower threshold than current law. House Republicans would lower the top rate on capital gains to
one‐half of the highest rate imposed on ordinary income, or 16.5%. Both President‐elect Trump and the House
Republicans have proposed repealing (and replacing) the Affordable Care Act, which is the source of the current
3.8% surtax. The Affordable Care Act is also the source of the extra 0.9% surtax on high‐income earners (wages
exceeding $250,000 for couples; $200,000 for singles) and other indirect tax increases such as the reduced cap on
flexible spending accounts and tighter rules for deducting medical expenses. A repeal of the Affordable Care Act
could lead to an immediate tax cut. President‐elect Trump would impose a $100,000 cap on itemized deductions
($200,000 for joint filers); the House Republicans would eliminate itemized deductions other than charitable gifts
and mortgage interest. Both President‐elect Trump and the House Republicans would eliminate the Alternative
Minimum Tax. President‐elect Trump’s proposal would tax the income from “carried interests” as ordinary
income.
Planning. At its most basic, income tax planning is (i) timing income so it is recognized in a lower‐tax year, and (ii)
timing deductions so they are deducted in a higher‐tax year. However, the proposals listed above contain both
“good news” and “bad news” for 2017, so we cannot offer a universal rule as to whether income or deductions
are better recognized in 2016, 2017 or even 2018. Each taxpayer needs to make an educated prediction. If there
is not a clear answer, sometimes it can make sense to recognize some income (or deductions) in one year and
some the next. That approach has the benefit of making sure you don’t completely pick the worse year.
The following are some general planning considerations.
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Installment sale. If a sale is made in return for an installment note, the resulting gain can be reported
on the installment method, meaning gain can be deferred into the year in which payment is received.
Not all assets can be sold via the installment method, and there are several special rules. For example,
marketable securities cannot be sold and reported using the installment method. We have a separate
Wealth Strategy Report: Installment Sales.
If a sale is made for an installment note, you can also elect to be taxed in the year of sale rather than
deferring the gain. This election must be made by the due date (including extensions) of the return
for the year in which the sale occurred. Thus, an installment sale in 2016 could allow you to wait until
as late as October 2017 to decide whether to use the installment method or report all the gain in
2016. This could allow a decision to be made with 20/20 hindsight, at least as of October.
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Equity‐based income. Certain types of compensation are tied to the value of an underlying stock. As
one example, a nonqualified compensatory stock option’s value will vary with the changing value of
the underlying stock. As another example, a grant of restricted stock will be taxed when it vests,
unless a so‐called “83(b) election” is made to be taxed at the time of grant. In either case, the amount
of compensation that is taxable will depend on the value of the stock at the appropriate time. When
deciding the most favorable tax year to recognize these types of equity‐based compensation, in
addition to the usual considerations of the applicable tax rate, it is important to account for the
expected investment performance of the underlying stock. As a simple example, deferring a stock
option exercise to the next year might produce a better result not because of a better tax rate but
because of the expected growth in the stock’s value.
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TAX ALERT 2016‐5: THE 2016 ELECTION: TAX CHANGES EXPECTED
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Roth conversions. It is generally better to convert traditional retirement funds to a Roth IRA in a
lower tax rate environment rather than a higher rate environment. For taxpayers who converted a
traditional IRA to a Roth IRA in 2016, the normal rules will provide a chance to review whether 2016
or 2017 would be the better year for a conversion. Generally, a 2016 conversion can be unwound
(“recharacterized”) as late as October 16, 2017. Following a recharacterization, the IRA could again
be converted to a Roth IRA 30 days later (assuming the original conversion occurred in 2016). Thus,
you could wait until October 2017 to determine whether 2016 or 2017 would be the better year for
conversion based on the relative tax rates, changes in the market value of the retirement funds and
other relevant considerations. If 2016, then you could let the 2016 conversion remain. If 2017, you
could “recharacterize” in October of 2017 and re‐convert 30 days later.
ESTATE AND GIFT TAX
Current law. Under current law, the federal exemption for estate and gift tax is $5 million, subject to an inflation
adjustment each year. For 2016, the exemption is $5,450,000, and for 2017, it is $5,490,000. For gifts or estates
above the exemption, the federal tax rate is 40%. If an appreciated asset is includible in the estate, it generally
receives a step‐up in basis for income tax purposes equal to the fair market value at death. Accordingly, there
would be little or no capital gains tax for appreciated assets sold soon after death.
Proposals. President‐elect Trump has proposed to repeal the estate tax. The House Republicans’ Tax Proposal
also proposes federal estate tax repeal. It would appear that such repeal would be temporary, unless the tax
changes proposed can be enacted on a revenue neutral basis. 2 It is not clear whether the federal gift tax would
also be repealed. The federal gift tax may be viewed as serving two purposes. First, it serves to support the estate
tax, because without it you could make unlimited gifts during your life and thereby avoid federal estate tax at
death. From that perspective, repealing the estate tax would suggest that the gift tax would also be repealed.
However, the gift tax also serves to support the federal income tax. Without a gift tax, income‐producing property
could be given to family members or others in a lower tax bracket (or residing in a state without an income tax),
and subsequently given back. From that perspective, repealing the estate tax would not suggest that the gift tax
also be repealed. Neither President‐elect Trump’s proposal nor the House Republicans’ Tax Proposal includes a
repeal of the gift tax.
As noted, appreciated assets includible in the estate generally receive a step‐up in basis. President‐elect Trump
has proposed to change this, however specific details have not been offered. The proposal sets forth a $10 million
exemption for gains at death. It is not clear whether this exemption is for each decedent, or if that is the combined
exemption for a married couple. It is also not clear whether any gains above the exemption would be subject to
capital gains tax at death (in effect a deemed sale at fair market value), or only subsequently when the asset is
actually sold. It is also uncertain whether any unused exemption could be transferred to a surviving spouse.
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In order to comply with the Reconciliation procedure, the repeal needs to “sunset,” resulting in reinstatement of the estate
tax after approximately 10 years. Under the 2001 Tax Act, there was a temporary repeal of the estate tax (and other taxes)
for this reason. Reconciliation rules will likely also add pressure to produce a revenue‐neutral tax bill in order to avoid such a
“sunset.” That could cause Congress to abandon repealing the estate tax.
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TAX ALERT 2016‐5: THE 2016 ELECTION: TAX CHANGES EXPECTED
Valuation discounts. On August 2, 2016, the IRS released proposed regulations, which may limit valuation
discounts for transfers of interests in family‐controlled entities. 3 These regulations contain many ambiguities,
and the IRS requested comments and held a public hearing on December 1, 2016. The regulations are
controversial, many comments were sent and only a few clarifying changes were provided at the hearing. As a
result of the election, we believe it is likely the IRS will not proceed with these regulations. For now, there has
been no official word from the IRS.
Planning. The proposal to repeal the federal estate tax appears straightforward, but will be complicated if it is
temporary. The possibility of reinstatement of the estate tax may be a reason for traditional estate planning
techniques, such as gifts and sales, to continue to be utilized. There is also significant uncertainty as to the related
federal gift tax and basis step‐up proposals. This makes current planning difficult because you may be comparing
the consequences of taking action currently (such as making a gift), with the uncertain future consequences of
not taking such action. Nevertheless, there are some general guidelines to consider.
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It does not appear advisable to make a current gift that requires the payment of gift tax. Although
the gift tax may be less costly than the estate tax, that would not be true if the estate tax is repealed.
There are many types of “free” gifts that do not require the payment of gift tax, such as annual
exclusion gifts, tuition and medical gifts, gifts utilizing the lifetime gift exemption, and zeroed‐out
GRATs.
o
o
If such gifts are being considered only to save estate tax, it does not appear necessary to make
these gifts, unless there is an applicable state estate tax 4 . However, if repeal is temporary
and the estate tax will be reinstated, then such gifts may continue to be advisable.
If such gifts are being considered for other non‐tax reasons (such as benefitting the recipient
or asset protection), such gifts may still be beneficial. Even if the gift tax were repealed, you
would still have made the gift for free.
o If a gift will be made currently, it may be advisable to include flexible provisions, such as a
trust which allows for discretionary distributions to the donor’s spouse. This could allow the
gift to be “undone” in the future by distributions to such spouse, if that becomes desirable.
As to future planning, it will obviously depend on what changes are enacted. If the estate tax is repealed, or if
other significant changes are made, all wills, trusts and estate planning documents should be reviewed to
determine if any revisions are desirable. Since most wills have dispositive provisions, such as credit shelter trusts
and QTIP trusts, based on the estate tax, it will require a re‐thinking of estate planning and what dispositions and
trusts would be appropriate. Non‐tax considerations, such as trust provisions, asset protection and fiduciary
selection, will play an enhanced role. If federal estate tax repeal is only temporary, it will presumably be necessary
to include alternate dispositive provisions, in case the tax is reinstated.
CONCLUSION
The results of the 2016 election are expected to lead to significant income and transfer tax changes, some through
the potential repeal of the Affordable Care Act and others through a push for comprehensive tax reform. In this
Tax Alert, we have highlighted some of the tax proposals, and the possible impact these changes may have on
3
We have a separate Tax Alert 2016‐3, Proposed Regulations May Limit/Eliminate Valuation Discounts for Family Controlled
Entities.
4
Certain states impose their own estate tax, independent of whether the federal estate tax is repealed.
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TAX ALERT 2016‐5: THE 2016 ELECTION: TAX CHANGES EXPECTED
planning. It is our view that due to fiscal and political pressure to keep future budget deficits in check and the
narrow corridor which could result in the passage of a major tax bill (Reconciliation), we expect the tax bill to be
closer to the House Republicans’ Plan than the Trump Plan and perhaps narrower in scope. When more
information is available, we expect to issue a more detailed Tax Alert.
— National Wealth Planning Strategies
IMPORTANT: This publication is designed to provide general information about ideas and strategies. It is for discussion
purposes only since the availability and effectiveness of any strategy are dependent upon your individual facts and
circumstances. Clients should always consult with their independent attorney, tax advisor, investment manager, and
insurance agent for final recommendations and before changing or implementing any financial, tax, or estate planning
strategy.
Neither U.S. Trust nor any of its affiliates or advisors provide legal, tax or accounting advice. Clients should consult with their
legal and/or tax advisors before making any financial decisions.
U.S. Trust operates through Bank of America, N.A., and other subsidiaries of Bank of America Corporation.
Bank of America, N.A., Member FDIC.
© 2016 Bank of America Corporation. All rights reserved. | NWPSElection | Dec 2016
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