The 2020 election began in September 2020 with mail-in voting and finally came to an end on January 6, 2021. Democratic Senate candidates Jon Ossoff and Raphael Warnock won their respective races in the Georgia runoff elections, resulting in a 50-50 Democrat/Republican split in the U.S. Senate. With Vice-President Elect Kamala Harris slated to cast tie-breaking votes, Democrats will soon be in control of both chambers of Congress and the White House. As a result, many estate and tax law practitioners are anticipating the possibility of broad tax law reform proposed by President-Elect Biden during his campaign. Two such proposals may increase the amount of tax collected from a decedent's estate. Most notably, President-Elect Biden has proposed significantly decreasing the gift and estate tax exemption, resulting in potential increases of gift and estate tax liability for large estates. The Biden campaign also proposed eliminating the “step-up in cost basis” benefit, which limits taxation on capital gains by not taxing appreciation that occurs during a decedent's lifetime for certain assets that are transferred at death.
This article presents an overview of the impact of these two proposals and explains why the time to discuss the impacts of these potential changes with an estate planning attorney is now.
Estate Tax Reform Proposal: Increasing the Collection of Gift and Estate Tax by Decreasing the Gift and Estate Tax Exemption
The IRS imposes a tax on certain gifts made during an individual's life and property transferred as a result of an individual's death. Lifetime gifts are subject to gift tax and are reportable to the extent that the total value of gifts from a donor to a donee in a given year exceeds the annual gift tax exclusion amount—$15,000 in 2021 (under current law). At death, an individual's estate may be subject to estate tax if the date of death value of his or her taxable estate exceeds his or her remaining lifetime gift and estate tax exemption.
The gift and estate tax exemption allows a set value of lifetime gifts and transfers at death to be made free of gift and estate tax. At the beginning of 2017, the exemption amount was $5.49 million per individual, or $10.98 million for married couples who properly transferred the unused portion of the exemption to the surviving spouse. The Tax Cuts and Jobs Act of 2017 (“TCJA”) temporarily doubled the gift and estate tax exemption, subjecting fewer estates to estate tax and significantly decreasing the tax liability of many estates. The TCJA adjusts the exemption amount for inflation each year until 2025, at which time the exemption will be reduced to the pre-TCJA amount of $5.49 million (as adjusted for inflation).
The current gift and estate tax exemption is $11.7 million for individuals who die in 2021 or a combined $23.4 million for married couples. However, President-Elect Biden's campaign platform included a proposed decrease of this exemption to $3.5 million per individual or $7 million for married couples, which is significantly lower than the pre-TCJA amount. Along with this decrease, the Biden campaign proposed an increased tax to those estates in the top tax bracket from 40 percent to 45 percent. The substantial decrease in exemption in conjunction with the increased tax rate for estates in the highest bracket could subject many more estates to tax liability and significantly increase the tax imposed on estates larger than a few million dollars.
While the exemption may not ultimately be decreased as low as $3.5 million, the favorable Democratic makeup of the legislative and executive branches could yield a significant decrease in the exemption. Additionally, President-Elect Biden has not indicated whether his proposal would apply the decreased exemption retroactively to the beginning of 2021, which could impact transfers made in 2021 prior to any legislative action. Historically, decreases in the exemption amount have not typically applied to completed transfers. However, since there is no way to know for certain until legislation is drafted, this inquiry remains open and poses additional challenges to determining the best strategy for planned giving.
Estate Tax Reform Proposal: Eliminating the Step-Up in Cost Basis for Capital Gains
President-Elect Biden's campaign also proposed eliminating the step-up in cost basis for capital gains tax. Currently, a beneficiary's tax basis in inherited property is potentially “stepped-up” to the fair market value of the asset at the time of the decedent's death. In other words, instead of using an asset's value at the time of the decedent's acquisition of the asset as its cost basis for income tax purposes, the date of death value is used as the asset's basis. The tax benefit to the party inheriting the asset is often very powerful. If the inheriting party later sells that asset, the income tax is then based on the difference between the sale price and the stepped-up basis on the asset (not the decedent's lower basis).
By eliminating the step-up in cost basis, a beneficiary who inherits assets that have grown significantly during the decedent's lifetime will likely be required to pay much higher taxes when the asset is later sold. Individuals who anticipate that their beneficiaries will inherit assets with substantial unrealized growth should consider utilizing estate planning tools to avoid this potentially significant tax increase.
What Comes Next?
It is, of course, impossible to know whether President-Elect Biden's campaign proposals will become law during 2021, let alone whether the exact proposals made during the campaign will reflect the actual substance of future legislation. Moreover, the timeline of such changes cannot be known, particularly in light of the current pandemic and economic crisis, which will likely be the main focus of the Biden administration's first several months. However, these proposed tax law changes are undoubtedly more likely to become law now that there is Democratic control of both the legislative and executive branches. With so many unknowns at play, it is important to discuss the potential impacts of these proposed changes with your estate and tax planning attorneys, and other trusted advisors, early in 2021.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.