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Estate Tax Landscape for 2021 and Beyond

Estate Tax Landscape for 2021 and Beyond

Now that former Vice President Joe Biden is projected to be the President-elect, we can start to focus on the policy changes that may be coming. For months commentators have attempted to predict the economic and tax changes that would likely occur under President-Elect Joe Biden’s administration, and while the details are still to be worked out, it is clear that the tax burden for many clients will likely increase. Advisors are now in a better position to evaluate the possible tax ramifications of this election that may affect taxpayers as early as January of next year.

Throughout his campaign, Biden indicated that he would seek to repeal many, if not all, of the provisions of the Tax Cuts and Jobs Act (“TCJA”) which was enacted in 2017. Depending on Congress, some commentators have speculated that if new tax legislation is passed, the changes could apply retroactively to January, 2021.

In addition to changes to the ordinary income tax brackets, the elimination of the qualified business income tax deduction for pass-through business owners and 1031 exchange benefits for certain taxpayers, and the taxation of capital gains at ordinary income rates for certain taxpayers, Biden’s tax plan also proposes to make major changes to the current estate and gift tax regime.

Under the TCJA, the current exemption amount for estate, gift and generation skipping transfer (GST) tax is $10 million, adjusted for inflation, set at $11.58 million for 2020 and $11.7 million for 2021. This means that in 2020 individuals can transfer during life and at death up to $11.58 million of assets without paying federal estate, gift or GST tax. Any transfers above such exemption amount are subject to a tax rate of 40%. Married couples can double that amount and transfer collectively $23.16 million in 2020 without tax. The current law is scheduled to expire the $10 million base exemption on January 1, 2026 reverting the exemption back to the $5 million pre-TCJA base amount, as adjusted for inflation.

During Biden’s campaign, he proposed to expand the estate and gift tax by reducing the federal base exemption to the pre-TCJA amount of $5 million and potentially further back to the 2009 exemption amount of $3.5 million. In addition, Biden has proposed increasing the top tax rate from 40% to 45% for estate, gift and GST tax.

Another important planning strategy that may be repealed under the Biden tax plan is the step-up in basis at death. When an asset is sold, the appreciation on that asset is generally subject to capital gains tax. Currently, when an owner of assets dies, the tax basis of those assets transferred to the owner’s beneficiaries is increased (or stepped-up) or potentially decreased (stepped-down) to fair market value at death, essentially eliminating for the beneficiaries all capital gain (or loss) that has accumulated during the owner’s lifetime. Biden proposes to repeal this income tax planning opportunity, affecting individuals at all income and asset levels. It still remains unclear if Biden’s proposal would apply a tax on the unrealized appreciation at the decedent’s death or only upon a subsequent sale of the asset by the beneficiaries.

In light of these potential tax changes, it will be crucial for individuals to work with their legal and tax advisors to put plans in place that address these changes. High net worth individuals may want to consider making gifts to utilize the higher estate and gift tax exemption that is currently available, before it is reduced. Of course, the tax savings benefits of gifting need to be weighed against the practical need for cash flow for the remainder of an individual’s life. Beneficial gifting strategies may be to pay insurance premiums for Irrevocable Life Insurance Trusts (ILITs) or gifting interests in family businesses. Spousal Limited Access Trusts (SLATs) may become popular this year for high net worth individuals as they allow for use of the full estate/gift/GST exemption, but retain the assets for the benefit of the donor’s spouse, and indirectly, the donor. Individuals that have the liquidity available may also want to consider triggering gains during life on highly appreciated assets likely to further appreciate to prevent beneficiaries from inheriting the income tax liability associated with the appreciation on estate assets at death.

The next few months will require strategic decisions from clients and tax advisors that may include changes to financial and estate plans to utilize planning techniques that may not be available for much longer under the new administration.