A new year and a new President could mean potential shifts in estate taxes and tax exemptions. President Biden’s proposed plan could modify tax codes to almost anyone who has something of value to leave to heirs.
What does the new Biden tax plan mean for you and your heirs?
These proposals could:
- Lower the federal estate tax exemption to pre‑2009 levels, reducing them from $11.7M to 3.5MM to (a.k.a. reduction of gifting amounts)
- Eliminate “step up basis” of property transferred at death (a.k.a. increase taxes of assets at death, based on appreciation)
- Change and increase the capital gains tax structure through:
a. tax rates or reductions of certain current income tax benefits affecting charitable deductions
b. phase-outs of IRC Section 199A deductions for higher-income taxpayers (a.k.a. additional tax for increasing value and selling at profit)
Why should you care?
Well, it’s simple. You could owe a lot more taxes in the next several years if you don’t create a plan to liquidate, transfer or protect your assets planned for distribution. Or your heirs may inherit less and be taxed more at the time of your death. Shifting wealth to younger generations is going to be increasingly more difficult moving forward so it’s important to act now. Luckily, the pandemic and market volatility has impacted the valuations of many securities and businesses, making it an opportune time to gift or transfer assets out of your estate when interest rates and asset values are low.
Let’s talk details.
Though President Biden has not officially released his tax plan, his advisors have given some preliminary ideas on what may happen. Here is what we might expect.
- Tax Exemptions– Currently, the federal estate, gift and generation skipping transfer tax exemptions are generous and stand to be cut nearly in half. Right now, you may give gift your children or others up to $11.7 million in assets ($23.4 million for a married couple). President Biden’s campaign proposal hopes to reduce the exemption amount to $3.5 million each (for a total of $7 million for a married couple). This could go in to affect in 2021, but definitely by December 31, 2025, when the TCJA provision expires.
- Step-Up in Basis Could Be Eliminated- You may have never heard of stepped-up basis before, but you might be familiar with how it works. Step up in basis is when a person receives an asset after the benefactor dies and the asset often receives a “stepped-up basis,” which means the asset is given market value at the time the benefactor dies. Under current law, assets bequeathed to heirs were valued at the time of the owner’s death, even if the value had risen afterwards, and no tax was assessed for appreciation, if passed to heirs. For example: If a stock was bought for $1 and is now worth $10 when the owner dies, the capital gain is $9. But when that asset is passed on to heirs, the embedded gain is wiped out because the base value is now $10 and no capital gains tax is owed. This “step up in basis” practice is most likely going to be eliminated and heirs or the estate will have to pay tax on the appreciation.
- Capital Gains– President Biden has also proposed certain changes to the capital gains tax structure. These proposals could have an even greater impact, if accompanied by corresponding increases in taxes from the elimination of step-up basis.
Stepped-up basis continued…
By eliminating the step-up basis, and thereby modifying the way property is taxed after an individual’s death (meaning you will owe more in taxes based on appreciation), the beneficiary would be liable for the capital gains tax on the full amount of the appreciation, as well as, any depreciation recapture if the asset had been an investment subject to depreciation. A second proposal would essentially treat all property owned by the decedent as sold as his or her date of death. Any appreciation or recapture would therefore be taxed at death, but the beneficiaries would thereafter take the assets with a step-up in basis.
Regardless of any new legislation the Biden administration approves, one item is guaranteed by the end of 2025: increased taxes. On December 31st, 2025, 23 provisions from the Tax Cuts and Jobs Act will expire meaning most taxpayers will see a tax hike unless some or all provisions are extended. We aren’t predicting any tax changes be retroactive of January 1st but it could happen. Best planning approach? Make all your changes EARLY, and do not wait until Congress starts talking about the subject. Most frequently, tax changes are in the fall, so all changes should be made prior to Fall 2021, assuming you can avoid retroactivity.
Turn to Trusts to Minimize Tax Exposure:
If you have assets in excess of $7 million, consider your options to shift wealth to others with Annual Gifts (which remain at $15,000 for 2021) and additional gifts paid directly to educational and medical providers above those levels. Also consider making a large gift of a portion of your remaining lifetime credit (your “applicable exclusion amount”). While a large gift will use a portion of your lifetime credit, the IRS has indicated they will not “claw back” the credit amount in your estate if the exemptions fall.
Other options? Grantor Retained Annuity Trusts (“GRATs”) or Spousal Lifetime Access Trusts (“SLATs”) are attractive alternatives. These trusts provide a great opportunity for you to give away most of the future appreciation of assets while still retaining an income stream. The technique works to your advantage, when the assets you give grow in value at a rate larger than the rate the IRS tables assume the assets will grow. Currently the “table rates” are very low, so it is easy to achieve success. The lower the rate, the more effective it becomes in reducing your estate taxes. When valuing your gift, the value of your retained income stream is subtracted from the assets placed, so the taxable gift is only the amount that is assumed to be left for your heirs after your income stream stops.
Family Limited Liability Companies (“FLLC”s) provide another option for you in the event you have closely held business interests or real estate assets (such as rental property). You can include your children and other family members as “minority owners” (i.e. owning less than 50% each) by making “discounted” gifts of your interests to them. If you wish to maintain greater control, consider making gifts of non-voting interests. Finally, an individual could consider making gifts utilizing a formula transfer clause. The donor would make a gift of a fractional interest of an asset where the numerator is the donor’s available exemption on the date of the gift and the denominator is the fair market value of the gifted assets. If the exemption amount on the date of the gift is retroactively reduced, the formula should “self-correct,” so that the donor only gives away an amount equal to the donor’s available exemption on that date.
Next Steps To Preserve Your Legacy
Consider new planning strategies to reduce estate taxes while you can. As some tax exemptions are set to expire soon, it’s important to be proactive in revisiting your estate strategy, before the Biden administration releases their new tax plan. The pandemic and its effect on the economy continue to keep interest rates at historic lows, which makes this an ideal environment to engage in all aspects of estate planning, from the simple to the comprehensive. Now is the time to take stock of what is driving your estate strategy and think through existing choices and new options with the help of our team at Wiles. Our experienced estate planning attorneys can discuss certain techniques that can help you avoid an unintended gift or GST tax and will discuss how best to optimize the strategies going forward. Plan for your family. Protect your assets. Preserve your legacy. Find out how Wiles can help create a custom legacy plan for you. Call us today for a free consultation to review your existing plan or to create a new one. Don’t delay as tax laws could change in just a few months from now. Start planning today!
Sources:
https://www.natlawreview.com/article/2021-biden-plan-estate-planning-advisory
https://www.jdsupra.com/legalnews/post-election-estate-planning-18252/
https://taxfoundation.org/look-ahead-expiring-tax-provisions/