The Biden administration has floated some potential legislative changes that could impact estate planning strategies in the near future. These include four changes in particular that could have major estate planning ramifications:
- A lower lifetime gift and estate tax exemption — This exemption represents the total value of assets that you can give away to others while you’re alive or leave to them after you die that is not subject to federal gift and estate taxes. The exemption is currently $11.7 million per person, or $23.4 million for a married couple filing their income tax return jointly. However, these exemption amounts are scheduled to sunset at the end of 2025 and return to the previous limit of $5 million per person, adjusted for inflation (which would probably be between $6 million and $7 million by then). President Biden has informally proposed a reduction in the exemption to $5 million per person (or $10 million per couple) or $3.5 million per person (or $7 million per couple), which is where the exemption was before the Tax Cuts and Jobs Act of 2017.
- A higher estate tax rate — Currently, the federal estate tax ranges from 18% to 40% on assets that exceed the exemption (not total assets). For example, the tax rate would be 18% on up to $10,000 in assets that exceed the exemption amount and 40% on $1 million or more in assets that exceed the exemption amount. Various proposals have been discussed that would boost the top estate tax rate to 43% or create a new tiered rate scale with a top rate as high as 70% for the largest estates.
- Elimination of the step-up in basis — When you die, your assets will generally receive a step-up in basis whether estate taxes are due or not. In other words, the tax basis of your assets is adjusted to their fair market value at the time of your death, which allows your heirs to sell inherited assets without recognizing gains due to appreciation before you died. Some in the administration have proposed repeal of this step-up in basis, which would require heirs to pay capital gains taxes on the total appreciation in assets, including appreciation that occurred before you died. In some countries, capital gains taxes with no step-up in basis are assessed upon death instead of estate taxes. It’s even possible that heirs could be allowed to choose whether they want to pay estate or capital gains taxes as was the case in the U.S. previously.
- A higher capital gains tax rate — If the capital gains tax rate is raised to a level near ordinary income tax rates, it may be less beneficial to remove low-basis assets from a taxable estate. As the spread between these two tax rates becomes smaller, it may make less sense to try to avoid estate tax if the step-up in basis is eliminated.
Nothing is Settled Yet
It’s important to note that none of these ideas have made their way into legislation yet. Even with the Presidency and control of both Houses of Congress, some of these ideas may face stiff headwinds when it comes to becoming actual legislation.
Even if changes in estate tax law are eventually passed, the timing of these changes remains uncertain. If legislation is passed this year, it probably wouldn’t become effective until the first of next year — unless the changes are made retroactive to January 1, 2021. For legislation like this to be passed retroactively, it must be “rationally related” to a legitimate legislative purpose, which would appear to be questionable.
Generally speaking, it’s best not to make any major estate planning moves until much of this uncertainty is settled, which could happen over the summer. Making estate planning decisions based on incomplete information could negatively impact your family’s financial situation for years to come.
In the meantime, you can continue to use your annual gift exclusion of up to $15,000 per person, or $30,000 per married couple, as a way to reduce your taxable estate. These annual gifts can add up to substantial sums over time.
Give us a call if you have any questions about how potential changes in estate planning law could affect your family and what you can do to prepare.