By Kyle Graham
With Joe Biden as the President-elect and the fate of the Senate to be determined, one may want to consider estate tax planning strategies before 2020 concludes and before any potential new tax legislation may be enacted. During his campaign, Mr. Biden advanced several tax proposals that, if enacted, could have a significant impact on individuals and their tax and estate planning. These proposals include: (1) lowering the federal estate tax exemption; (2) changing the rules regarding the basis of property transferred at death; (3) reducing the amount that can be transferred by way of lifetime gifts; and (4) various changes to the income tax for both individuals and corporations.
Notwithstanding the results of the presidential election, there remains uncertainty regarding the future of the Senate, as two seats in Georgia will be filled through runoff elections in January 2021. It is unclear if Republicans retain the Senate, what reforms, if any, may be enacted and signed into law. Below is brief list of potential tax law changes that could occur, depending on the results of the election.
Potential Tax Law Changes
Reduced Transfer Tax Exemptions. Under current law, the estate, gift, and generation-skipping transfer tax exemptions are $11.58 million per person, or $23.16 million per married couple. In 2021, that amount increases to $11.7 million per person, or $23.4 million per married couple. In 2026, the current law sunsets, and the exemptions drop to $5 million per person, or $10 million per married couple, with anticipated adjustments for inflation. It is believed that Mr. Biden and a Democrat-controlled Congress could reduce the transfer tax exemptions to $3.5 million per person, or perhaps even lower, before the scheduled sunset in 2026. Additionally, there is the possibility that the exemption amount specifically relating to gifts could be reduced to $1 million, and the annual gift tax exclusion amount, currently at $15,000 per recipient, could also be reduced. Unfortunately, all of this is subject to conjecture. What is known is the law as it exists currently in 2020.
Increased Transfer Tax Rates. The current tax rate for transfers in excess of a taxpayer’s estate, gift, or GST exemption is 40%. In addition to reducing the exemption amount, the transfer tax rate could also increase, perhaps to 45% or higher.
No Step-Up in Basis at Death. Most assets that pass through one’s estate receive an income tax basis adjustment to fair market value as of the date of death. Mr. Biden has proposed eliminating this “step-up” in basis at death, which would result in higher capital gains taxes on inherited assets. The thinking at the moment is that it would be an “either/or” proposition. That is, most do not believe that the exemption would be reduced together with changes to the basis adjustment rules at death. Even if the changes to the basis adjustment are enacted, there would most likely be some form of relief for assets passing to a surviving spouse or to charity.
Increased Income and Capital Gains Tax Rates. Mr. Biden has also proposed increasing the top marginal individual income tax rate from 37% to 39.6%, and the top marginal corporate income tax rate from 21% to 28%. Further, Mr. Biden and a Democratic regime also propose taxing capital gains at ordinary income tax rates. Currently, capital gains are taxed at a maximum rate of 20%.
Timing of Tax Law Changes
It is unclear when changes, if any, to the tax laws will take effect. However, most practitioners believe any such changes would not be effective until after the legislation is enacted. Nonetheless, if the transfer tax laws change during 2021, the changes could be made retroactive such that the effective date of the legislation is January 1, 2021. There is also the possibility that changes to the tax laws would occur after 2021, such as in 2022 or subsequent years. With a recognized need for revenue, changes to the income tax system may occur sooner than changes to the transfer tax system. Therefore, if tax changes are to occur, it may be that income tax takes priority over transfer taxes. At this time, unfortunately, this is a “guessing game” to a certain extent.
2020 Estate Planning Considerations
Consider Using “Bonus” Exemptions Before They Expire. If the transfer tax exemptions are reduced, taxpayers should use their “bonus” exemptions before they go away, otherwise they risk losing them forever. A taxpayer may elect to use the bonus exemption in 2020, and the IRS has stated that there will not be a “claw back” if the exemption is decreased in 2021 or future years. However, one drawback to this approach may be that gifts made now will lose their ability to receive a step-up in basis at the death of the donor. Nonetheless, taxpayers who may have a taxable estate should consider utilizing the increased exemption while they still can.
Take Advantage of Low Interest Rates and Depressed Asset Values. In many cases, estate planning is most effective when interest rates are low and asset values are depressed. Examples of possible planning options to utilize the current low interest rates include family loans, note sale transactions, and grantor retained annuity trusts (GRATs).
Do not wait until year-end. Many professionals anticipate a heavy caseload through the end of 2020, which may be further complicated by difficulties associated with COVID-19. The time to have conversations with your professionals is now.
Currently, we do not have an answer as to what changes to the tax laws will occur, if any. Much uncertainty remains, especially with the upcoming runoff elections in Georgia. With a need for revenue, income tax changes may be at the forefront for the next regime. Although the tax landscape could change significantly soon, it is important to recognize that each person’s situation is unique and requires individualized consideration and advice. If you have questions regarding how the recent election will impact your estate plan, please contact one of McCarthy Lebit’s tax and estate planning attorneys.