The 2020 election began with a postal vote in September 2020 and ended on January 6, 2021. Democratic Senate candidates Jon Ossoff and Raphael Warnock won their respective races in the Georgia runoff, resulting in a 50:50 Democrat. Republicans split in the US Senate. After the elected Vice President Kamala Harris casts votes, the Democrats will soon have control of both houses of Congress and the White House. As a result, many estate and tax lawyers anticipate the possibility of a major reform of the tax law proposed by President-elect Biden during his campaign. Two such proposals can increase the amount of tax levied on a deceased’s estate. In particular, President-elect Biden has proposed significantly lowering the gift and estate tax exemption, which can potentially increase tax liability on gifts and large estates. The Biden campaign also suggested removing the benefit of a “cost base increase” which limits the taxation of capital gains by reducing the increase in value that occurs during the lifetime of a deceased for certain assets that are transferred at the time of death , is not taxed.
This article provides an overview of the implications of these two suggestions and explains why the time has come to discuss the implications of these potential changes with an estate planning attorney.
Proposal to reform the estate tax: Increase the collection of gift and estate taxes by reducing the exemption from gift and estate taxes
The IRS imposes a tax on certain gifts given during a person’s life and property as a result of a person’s death. Lifelong gifts are subject to gift tax and are reportable to the extent that the total value of a donor’s gifts to a recipient in any given year exceeds the annual gift tax exclusion amount – $ 1,521 in 2021 (under applicable law). In the event of death, an individual’s estate may be subject to estate tax if the death date value of their taxable estate exceeds the remaining lifetime gift and estate tax exemption.
The gift and estate tax exemption allows a fixed value for gifts and transfers to be made free of gift and estate tax for life upon death. At the start of 2017, the exemption amount was $ 5.49 million per person, or $ 10.98 million for married couples who duly transferred the unused portion of the exemption to the surviving spouse. The 2017 Tax Reduction and Employment Act (“TCJA”) temporarily doubled the gift and estate tax exemption, reducing the inheritance tax charge to fewer estates and significantly reducing the tax liability of many estates. The TCJA adjusts the inflation exemption amount each year through 2025. At this point, the exemption will be reduced to the pre-TCJA amount of $ 5.49 million (adjusted for inflation).
The current gift and estate tax exemption is $ 11.7 million for those who die in 2021 or $ 23.4 million for married couples. However, President-Elect Biden’s campaign platform included a proposed lowering of this exemption to $ 3.5 million per person or $ 7 million for married couples, which is well below the pre-TCJA amount. Along with this decline, the Biden campaign proposed an increase in tax on those goods in the upper tax bracket from 40 percent to 45 percent. The substantial reduction in the exemption coupled with the increased tax rate on estates in the top tier could result in many more estates being subject to tax liability and a substantial increase in tax on estates greater than a few million dollars.
While the exemption cannot ultimately be reduced to just $ 3.5 million, the favorable democratic makeup of the legislature and executive could result in a significant reduction in the exemption. In addition, President-elect Biden has not indicated whether his proposal would apply the reduced exemption retrospectively to the beginning of 2021, which could affect the carryovers made in 2021 before a legislative measure. In the past, a reduction in the exemption amount did not normally apply to completed transfers. However, as there is no way of knowing for sure until the legislation is in place, this research remains open and poses additional challenges in identifying the best strategy for planned donations.
Proposal to reform the estate tax: Eliminate the increase in the cost base for capital gains
President Elect Biden’s campaign also proposed eliminating the increase in the capital gains tax cost base. At present, a beneficiary’s tax base on inherited wealth may be “increased” to the market value of the asset at the time of the death of the deceased. In other words, instead of using the value of an asset at the time the asset was acquired by the deceased as the cost base for income tax purposes, the value of the date of death is used as the base of the asset. The tax benefit for the party who inherits the asset is often very high. If the inheriting party later sells that asset, income tax is based on the difference between the sale price and the increased base for the asset (not the deceased’s lower base).
By eliminating the increase in the cost base, a beneficiary who inherits assets that have grown significantly over the life of the deceased is likely to have to pay much higher taxes if the asset is later sold. Individuals who anticipate that their beneficiaries will inherit assets with significant unrealized growth should consider using estate planning tools to avoid this potentially significant tax hike.
It is of course impossible to know whether President-elect Biden’s campaign proposals will become law in 2021, let alone whether the exact proposals made during the campaign reflect the real content of future legislation. Furthermore, the timing of such changes may not be known, especially given the current pandemic and economic crisis that will likely be the main focus of the first few months of the Biden administration. However, it is undoubtedly more likely that these proposed changes to tax law will become law now with democratic scrutiny from both the legislature and the executive. With so many unknowns, it’s important to discuss the potential impact of these proposed changes with your estate and tax planning attorneys and other trusted advisors in early 2021.