Changes to Both Gift and Estate and Capital Gains Taxes expected under Biden’s administration
President Joe Biden presented reform strategies during his presidential campaign creating a prudent need for high net worth families to review their estate plans early in 2021. While campaigning, President Biden proposed several tax changes, with two of them significant estate planning tax changes. The first is a premature reduction of the gift and estate tax exemption from the Tax Cuts and Jobs Act of 2017. The second is ending the step-up in tax basis for capital gains taxes on inherited property. Let’s take a look at both.
The Democrats control the House with an 11 seat advantage over the Republicans; the Senate is evenly split between the Democrats and Republicans, with Vice President Harris carrying the tie-breaking vote; and President Joe Biden and Vice President Kamala Harris have been sworn into office. While trying to predict what will happen in Washington DC is nothing but speculation, and the Senate is still tightly paired, it’s fair to expect that some Democratic initiatives will pass.
One could argue that with the Federal government spending trillions of dollars on COVID relief (and more aid expected) that additional tax revenue will be needed to reduce the deficit. Targeting the most affluent families in the country would be productive and impact a small percentage of Americans, thereby incentivizing high net-worth families to engage in tax planning.
Potential Gift and Estate Tax Reduction
A look back to 2017
In 2017, President Trump signed the Tax Cuts and Jobs Act of 2017, temporarily doubling the then $5.49mm gift and estate tax exemption to nearly $11mm (almost $22mm per married couple).
Today, the gift and estate tax exemption is $11.7mm per person ($23.4mm per married couple). Absent any further action, the federal estate tax exemption will revert to $5 million (indexed to inflation) in January 2026.
Click here to read our blog from 2018 about the 2017 Tax Reform Act.
President Biden has proposed lowering the gift and estate tax exemption to as low as $3.5mm and increasing the tax rate from 40% to 45%.
What does this mean?
For simplicity, we will discuss numbers for a single person. The amounts for a married would be double.
A person with a current (or expected at passing) net worth above $3.5mm could benefit by establishing an irrevocable trust to shield their assets from the estate tax. Nevada’s Dynasty Trust provisions can insulate assets from estate taxes for many future generations.
Today (Feb 2021), a person with an estate valued at $11.7mm now would not be subject to an estate tax if they passed. However, with the proposed Biden tax plan, up to $3.7mm of additional estate tax would be due ($11.7mm – $3.5mm = $8.2 million. A 45% estate tax would be due on the $8.2mm equaling to a tax bill of $3.7mm).
I reached out to Los Angeles estate planning attorney Dennis Huang (Squire Patton Boggs) for insight into the potential tax changes’ planning impacts.
“A return of the estate and gift tax exemption to 2009 rates would affect significantly more families, and a potential elimination of a step up in basis would affect everyone who owns an appreciated asset, whether a family home or Apple stock purchased in the 1990s. There is a window of opportunity at this time for families to do some wealth transfer planning while the exemption is still at historically record levels.”
Dennis Huang, Esq.
Repealing the Step-up in Basis for Capital Gains
Presently (February 2021), when an inheritor inherits property upon a decedent’s passing, the inheritor’s tax basis on the inherited property will be the fair market value at the time of inheritance rather than a tax basis from when the decedent acquired the property.
Biden has proposed eliminating the current “step-up” on tax basis for inherited property.
Let’s Take a Closer Look At the Potential Impact of Eliminating the Step-up
A decedent purchased a piece of art in 1960 for $1,000. Upon her passing, the piece is appraised and valued at $100,000. The inheritor acquires the art piece.
Under the current tax law, the inheritor’s tax responsibility upon selling the art piece is based on the selling price above the $100,000 appraised value. Thus, if the beneficiary sells the piece for $100,000, the inheritor would owe no capital gains tax on the sale.
Under Biden’s proposed repeal of the step-up in basis, the inheritor’s tax responsibility would be based on the decedent’s purchase price of the piece: $1,000. Thus, if the inheritor were to sell the piece at its market value of $100,000, the inheritor would owe 10-37% (depending on the inheritor’s income) in capital gains tax on the $99,000 appreciation of the piece.
Apply Biden’s proposed changes to real estate, businesses, and other assets with high appreciation or volatility, and the impact from eliminating the step-up in basis exponentially increases.
As of now, many business owners’ estate plans are structured such that if the spouse inherits the owner’s business, there are no capital gains taxes due at the business owner’s death due to the current step-up. Biden’s proposed step-up changes may create a need to change the “second-to-die” planning of many families with planning solutions such as life insurance or trust planning at the business owner’s death.
Potential Tax Reform Action Items
Should the Biden administration and Congress choose to change the estate and gift tax laws in 2021, while Congress can make these laws retroactive to January 1st, the changes would indeed be challenged in the court system, potentially up to the Supreme Court of the United States (“SCOTUS”). With the conservative SCOTUS justices in the majority, while difficult to guess what the court would do, it is plausible that the challenge would gain traction.
Potentially, the laws could be changed for 2022 and beyond, leaving almost a year-long planning window. For planners and clients, the best course of action is to review their estate plans ensuring they are crafted in the most advantageous strategies possible in the case of significant tax changes in the near future.
Nevada carries outstanding tax and trust laws. Meeting with planning professionals specializing in Nevada estate planning makes sense for affluent families and their advisors. Alliance Trust is happy to provide further information and may connect you to our network of planning professionals.