While there are many new tax policy implementations that could be imminent with the new Biden administration, there are two changes that estate planning lawyers in particular are closely monitoring. These include (1) a reduction in the inheritance tax exemption and (2) a lifting of the base increase for inherited estates. Unfortunately, there is still no way of predicting exactly what will happen or when these changes will take effect, but the current climate presents a unique opportunity for individuals to use some wealth transfer planning strategies, such as lifelong endowments if they do inclined.
REDUCTION OF TAX EXEMPTION
Under the current provisions of the Tax Cut and Employment Act, the estate, gift and generational change tax (GST) tax exemption amount is $ 10 million, adjusted for inflation, increasing to $ 11.58 million in 2020 and $ 11.7 million in 2020. In 2021, this means individuals could transfer up to $ 11.58 million in assets during their life and death in the final year without paying estate, gift, or GST taxes[1]. Transfers over this exemption amount are subject to a tax rate of 40%. Married couples can double that amount and transfer a total of $ 23.16 million last year with no estate tax consequences.
This current federal exemption will automatically reset to approximately $ 6 million on January 1, 2026. However, with a new president and a realignment in the House and Senate, this exemption may decrease much sooner. There is speculation that these new exemption amounts will be set at $ 6 million, but they could also be set at $ 3 million. Further speculation concerns whether these tax changes will only take effect in the future or whether they will be made retrospectively at the beginning of the year in which they come into effect.
What can individuals do about it?
Individuals have options, but ultimately must decide whether to take advantage of their tax benefits now before changes can become law, taking into account that the change may be retrospective, or have to wait and see how the year goes. Individuals who want to take advantage of the benefits can give small and large gifts that benefit from the current tax exemption. Given that these options consist of irrevocable transfers, the benefits must always be weighed against an individual’s practical need for cash flow for the rest of their lives.
In addition to the well-known annual exclusion gifts, which currently stand at USD 15,000.00 per recipient, advantageous gift strategies can include giving current interests to family businesses or establishing an irrevocable life insurance trust (ILIT), in which payments are made to insurance premiums. Spousal Limited Access Trusts (SLATs) are also a popular tool for high net worth individuals as they allow full exemption but still keep the assets in favor of the donor’s spouse and indirectly the donor. Grantor Retained Annuity Trusts (GRATs) and Intrafamily Loans are other effective estate planning strategies as long as interest rates stay low. Regardless of the strategy used, they can all help extract assets from a person’s estate which would help reduce future estate tax consequences.
ELIMINATION OF THE BASIC STEP-UP
Another possible policy change involves eliminating the death-based step-up, which may affect more taxpayers than reducing tax exemptions. For decades, assets have been valued at the time of the owner’s death, even if their value has increased or appreciated. For example, if your uncle bought a home for $ 150,000.00, but the house is worth $ 350,000.00 at the time of his death, the profit on that home will be $ 200,000.00. However, that gain will be wiped out if that asset is passed on to its heirs, as the base value has “risen” to $ 350,000.00 and therefore no capital gains tax is due. This treatment applies to all assets, from real estate to stocks and shares. If the total value of the estate is below the current exemption level, your uncle would also not have to pay estate tax.
If, on the other hand, the Biden administration cancels the basic step-up rule, this means that this gain can now be recognized during the transfer. If a profit is recognized it could potentially have significant tax consequences for those who inherit assets with high appreciation values.
What can individuals do about it?
In a situation where the top-up base is no longer available, individuals can take a look at their entire financial portfolio and redefine a strategy of which assets could benefit from a trust relationship. Assets with a greater embedded capital gain could be brought into the trust while other assets such as cash could now be gifted or otherwise left directly to the heirs. This could potentially help minimize the capital gains tax their heirs would pay.
While we can’t be sure what changes will occur or when they will take effect, if you are concerned you should consider options that could help protect your assets and heirs from future undesirable tax consequences. Individuals willing and ready to give away assets may want to consider various strategies to take advantage of the current exemption from the higher estate and gift tax before it is reduced. These strategies can include a variety of different types of trusts including ILITs, SLATs, and GRATs, to name a few, designed to protect assets from estate taxes and capital gains. Talk to your lawyer and tax planner to determine if any of these trusts are right for you.
[1] This article does not cover government-implemented estate, gift, or GST taxes.
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