Election day has now come and gone and it was certainly an election like none that I can remember. Then again why shouldn’t the presidential election match the very strange year that has been 2020. Although there are still a number of pending court cases regarding the election results, most experts agree that Joe Biden is now the President-elect. With that said, we now need to consider the potential changes to tax laws with the new administration. Please keep in mind that this is a discussion of possible changes, but nothing is certain until a new law is signed by both houses of Congress and the President.
Estate Tax Exemption
The Biden tax platform takes aim at numerous aspects of the tax code, but we will only focus on a few key areas directly related to estate planning. The first tax adjustment that seems plausible is a reduction of the estate tax exemption. The current estate tax exemption is $11.58 million per person, with an effective tax rate of 40%, which means an estate pays 40% tax on any amount over that exemption. This was signed into law by President Trump under the Tax Cuts and Jobs Act of 2017, but is due to expire at the end of 2025. This means that unless action is taken, the estate tax exemption is already destined to revert back in 2026 to a lower exemption amount of $5 million (as indexed for inflation). The lower exemption of $5 million (as indexed for inflation) is a result of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. President-elect Biden’s platform leans toward a reversal to 2009 estate tax numbers. This would reduce the estate tax exemption to $3.5 million per person, with an effective tax rate of 45%. A recent study by the Tax Foundation predicts over the next 5 years there would be an additional $148.1 billion in tax revenue as a result of the estate tax exemption change to $3.5 million.
While a reduction in the estate tax exemption will certainly impact many families, the overall percentage of those affected compared to the total population of the United States is still quite low. Please keep in mind that even with estate tax exemptions reduced to $3.5 million per person, revocable living trusts are still a very effective tool to utilize both spousal exemptions for married couples. Using a trust plan could allow $7 million to pass estate tax free to beneficiaries. Not to mention, other planning options that have become less common in recent years due to the high exemptions are still available. Just to name a few: irrevocable life insurance trusts, qualified personal residence trusts and charitable remainder trusts remain viable options if the size of the estate exceeds the available exemption.
Cost Basis
The second significant change under the Biden tax platform directly impacts the treatment of capital assets and specifically capital gains taxes. The current law indicates that any capital asset held by someone at their death receives a step-up basis to the date of death value for the recipient of this asset. This is very helpful to beneficiaries receiving low-basis businesses, depreciated real estate, and/or stocks with an unknown or very low basis. With the current capital gains laws in place, beneficiaries receive a preferential tax treatment and are unburdened with having to research the original basis of the inherited asset.
President-elect Biden has indicated a desire to remove the step-up in cost-basis for those inheriting capital assets. Details are not complete on the exact treatment, but it is possible a new law could treat death as a deemed sale of the capital asset to the new beneficiary. This would force capital gains taxation on the decedent’s estate. Unrealized capital gains for a taxpayer with income less than $1 million could see rates of 15% or 20%. Under the Biden tax plan, taxpayers with income in excess of $1 million would have capital gains treated as ordinary income, thus potentially reaching a 39.6 % tax rate. The Net Investment Income Tax could add an additional 3.8% tax for a grand total of 43.4%. Pursuant to analysis completed by the Tax Foundation, over the next five years, this change to the taxation of capital assets would bring in an additional $168.7 billion dollars of tax revenue.
The initial hit from capital gains taxes combined with the final blow from estate taxes could simply devastate an estate. If for example an individual’s estate of $100 million (all of which was considered capital gains for this example) was subject to the new Biden tax plan, there would be an initial capital gains tax of $43.4 million and an additional estate tax of $23.9 million on the remaining assets. This would result in a total tax of $67.3 million and a remaining balance for beneficiaries of $32.7 million. This is an extreme example used to illustrate the impact of potential tax changes and in most scenarios a decedent’s assets are unlikely to all be subject to capital gains taxation.
There are a variety of strategies that can be used to mitigate these tax burdens, but strategic planning is the key. Some of these tax-reduction strategies must be implemented decades before death. The dilemma we all face is whether to adjust your estate plan for the potential future changes in the law, or draft your plan under the laws we know to be in effect. More often than not, speculating on potential legal changes is really just that; speculation. Planning for the known tax laws while leaving room for flexibility is a much more desirable strategy.
JGB keeps our clients informed of any changes in the law, and will continue to do so in the future. Just this year the Secure Act brought changes to the treatment of retirement accounts that necessitated updates to many of our client’s documents. If you have questions or would like to discuss any changes to your current plan, please contact our office so we can schedule a document review at your convenience.
TrustGuard™ 2021
TrustGuard™ enrollment for 2021 will be opening soon and is a sound decision given the legal uncertainty we face in 2021. TrustGuard™ is our proprietary program, designed for our clients who are serious about protecting their investment in their Trust-based Estate Plan with an annual review. A subscription to TrustGuard™ includes an annual review of your estate plan and funding for the enrollment year, along with any required changes to your plan. Enrollment invitations will be sent out to all our currently enrolled TrustGuard™ clients, as well as our clients who executed new trust documents in 2020.
The enrollment for the 2021 TrustGuard™ period begins in December and ends on February 28, 2021. JGB clients who choose not to re-enroll during the enrollment period will not have another opportunity to become members of TrustGuard™.
Participation in TrustGuard™ is entirely voluntary. The TrustGuard™ enrollment subscription is billed at an annual flat rate. Clients who pay their enrollment in full prior to February 1, 2021 receive a $100 discount off the price of full enrollment. Contact our office if you are interested in subscribing to the TrustGuard™ program.