Since the 2021 federal gift and estate tax exemption was raised to $11.7 million per person by the Tax Cuts and Jobs Act in 2017, the vast majority of individuals and families haven’t had to worry about having to pay the federal estate tax.
For example, only 1,900 estates were subject to the federal estate tax in 2020, which represents less than 0.1 percent of the approximately 2.8 million people who died last year.
But this could all change soon if revisions proposed by the Biden administration become law. These proposed revisions include a decrease in the gift and estate tax exemption (with no future increases due to inflation adjustments), an increase in the tax rate for gifts and estates that are subject to taxation, a partial removal of capital gains step up in basis for certain assets bequeathed at death, taxing capital gains already in irrevocable trusts every 21-30 years, incurring an income tax gain upon transferring assets to an irrevocable trust, and a reduction in the amount of money that can be given away annually without incurring gift tax.
The Nuts and Bolts
Under current law, you can transfer up to $11.7 million to other individuals either during your lifetime or at death without paying any federal gift or estate tax. Together, you and your spouse can transfer up to $23.4 million gift- and estate tax-free. In addition, you could potentially transfer this amount to grandchildren, either outright or in a trust, without incurring generation-skipping transfer (or GST) tax.
The Biden administration proposal would sharply reduce the exemption to just $3.5 million for asset transfers at the time of death, and just $1 million for gifts made during your lifetime. In addition, it would increase the tax rate for gifts and estates above the exemption from the current flat 40% to the following graduated scale:
Currently, the cost basis for inherited assets is generally the value of the assets on the day when the person from whom they were inherited died. As a result, capital gains tax is only paid on any appreciation in value that occurs after this date.
The Biden administration proposal would remove this step up in cost basis for any gains above $1 million on inherited assets. This threshold would increase to $2 million if the assets were inherited from a married couple. In addition, up to $250,000 of gain per decedent ($500,000 per couple) would be exempt for a principal residence. The removal of step up in basis could result in additional income taxes due when inherited assets are eventually sold. Or gains could be realized when the owner passes away, which would create an income tax liability on the decedent’s final income tax return.
Additionally, for assets that are gifted to an irrevocable trust in the future, the proposal would deem this transfer to be a taxable event. Therefore, the gross value of the underlying asset could not be transferred to an irrevocable trust without first incurring income tax. In addition, gifts to irrevocable trusts would no longer be eligible for discounts as a result of certain assets being illiquid or a minority interest.
The proposal would also generally lower the $15,000 (or $30,000 for a married couple) that can currently be given away annually free of federal gift tax to just $10,000 (or $20,000 for a married couple). It would also impose a $20,000 total limit (not annual limit) on the amount of gifts that can be given to anyone in a trust or involving family entities.
Even for existing irrevocable trusts, the proposal could cause gain recognition by essentially causing all irrevocable trust assets to be sold every 21-30 years (depending on the exact proposal), without actually selling the underlying assets. This would help curtail assets in irrevocable trusts from appreciating for several decades with no or minimal incurred income tax.
Finally, the proposal would include provisions that significantly limit the benefits of grantor retained annuity trusts (GRATs), severely eliminate the income tax and estate tax advantages associated with grantor trusts, and count prior lifetime gifts toward the $1 million gift tax exemption (although prior gifts exceeding the $1 million limit would not be negatively affected).
Steps to Consider
Under different proposals, these changes would be effective for any deaths and transfers that occur beginning January 1, 2021, or January 1, 2022. However, the probability of these changes being made retroactively becomes smaller as the year continues. So now is the time to start preparing for their potential impact. Here are a few steps to consider:
- Make gifts now to use your current gift tax and GST exemptions before they decrease.
- Complete any new irrevocable grantor trusts as soon as you can.
- Accelerate planned future gifts to the current year.
- Reexamine your strategy as it relates to low-basis assets you may not have sold, thinking that a step up in basis will eliminate capital gains taxes for your heirs.
Start Planning Now
The estate planning process can be complex and involve many different steps. Making changes can take several months or longer, so now is the time to get started. The first step is to review your current estate plan with your financial advisor to determine if any revisions should be made in light of these and other proposed changes.
An experienced trust and estate planning professional can help you conduct an estate planning review and offer expert guidance regarding whether any changes should be made.