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November 4, 2020

Potential Changes to Gift and Estate Tax Laws in 2021 and Beyond

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With the 2020 presidential election we could see some major changes to U.S. tax laws depending on the outcome at the polls (still unknown at the time of this writing). There are stark differences between the two leading candidates’ tax platforms. With a re-election of Republican President Donald Trump, many of the current tax laws are likely to be upheld; whereas a win by Democratic presidential candidate Joe Biden could bring significant tax reform. Furthermore, if these reforms were to pass in 2021, it is possible the changes will be retroactive to January 1, 2021.

Among those tax laws that could be impacted by a change in leadership are gift and estate tax laws. Considering these tax laws is an integral part of any comprehensive estate plan. Let’s take a look at some of the proposed changes to current gift and estate tax laws and how they might affect your current estate plan.

Decrease in the Lifetime Exemption Amount

The lifetime gift tax exemption amount is the amount individuals can give away during their lifetimes without having to pay any gift taxes on the transfer to the recipients. The lifetime gift tax exemption is unified with the federal estate tax exemption amount, meaning they are the same amount, which is the total amount one can exclude from estate taxes at death.

In 2020, the lifetime exemption amount is $11.58 million per person. This amount was temporarily increased under the Tax Cuts and Jobs Act of 2017 (TCJA), which was signed into law by President Trump and went into effect on January 1, 2018. Prior to that, the lifetime exemption amount was approximately $5.5 million per person. The $11.58 million exemption amount is scheduled to sunset at the end of 2025, at which time it would revert back to pre-2018 levels, indexed for inflation.

If presidential candidate Biden wins the election, it is likely that he will propose legislation to lower the lifetime exemption amount to pre-2018 levels prior to 2025, which would be somewhere around $5.5 million but potentially to levels as low as $3.5 million per person.1

If President Trump wins re-election, he has proposed making the TCJA changes permanent.2

Increase in the Federal Estate Tax Rate

The federal estate tax is a tax on the transfer of wealth during an individual’s lifetime or after death. This tax is imposed on the portion of an estate that exceeds the lifetime gift and estate tax exemption amount.

At present, the top federal estate tax rate is 40% and has been in effect since 2013. Prior to 2013, it was 35% for a few years, and before that it floated between 45%–55% beginning in the mid-1980s. Historically, the top estate tax rate reached its highest levels in the 1940s at 77%.

Presidential candidate Biden has discussed returning the estate tax rate to “historical norms,” which speculations suggest would be around 45%–50%, but there has been talk that the top marginal rate could go as high as 70%.3

President Trump would likely maintain the current top rate of 40%.4

Elimination of the Step-Up in Basis

A step-up in basis is an adjustment to the cost basis of an appreciated asset to its fair market value at the time of the owner’s death. Retaining appreciated assets and waiting for a step-up in basis is a technique that has been used in estate planning for decades to avoid paying capital gains taxes on highly appreciated assets. One successful estate planning strategy has been to gift high-basis assets (i.e., those with low appreciation) during life and retain low-basis assets (i.e., those with high appreciation) to transfer at death, at which time the assets would receive a step-up in basis and beneficiaries could sell the assets without incurring any capital gains taxes.

Presidential candidate Biden has indicated that he may propose eliminating the step-up in basis for inherited assets.1 It is not yet clear whether Biden’s plan would call for the beneficiaries to receive a carryover basis, in which case they would inherit the asset with the donor’s original basis, or whether beneficiaries would be forced to pay capital gains taxes on the unrealized appreciation of the asset at the time of inheritance.

President Trump’s plan would maintain the status quo as it relates to the step-up in basis for inherited assets.4

Changes to GRATs

A GRAT, or grantor retained annuity trust, is a specific type of trust that is often used for transferring wealth in a tax-efficient way. The grantor makes a gift to the trust and receives an annuity stream from it for a specified period of years, typically ranging between two and 10 years. For gift tax purposes, a gift is made at the time the grantor transfers assets, and the gift amount is based on the “remainder” amount calculated by a government-defined formula. If a GRAT is structured properly, at the end of the GRAT term, any assets remaining in the trust may pass to the remainder beneficiaries free of any gift or estate taxes.  

Under presidential candidate Biden’s plan, it is possible a minimum term of 10 years would be mandated for any future GRATs. This reduces the attractiveness of GRATs because the longer time horizon increases the potential for a downturn in the market, which would limit the opportunity to earn gains on the assets. Furthermore, the creation of a GRAT would produce a taxable gift equal to the greater of 25% of the trust assets or $500,000.5

President Trump has not made any statements regarding whether he would make changes to GRATs at this time.4

While all of these potential changes are still speculation, changes to the gift and estate tax laws could create some planning opportunities to explore this year to better position yourself for the future. If you would like to learn more about how these potential changes might affect your estate plan, please contact your B|O|S wealth management team.

Footnotes:

1 Garrett Watson, Huaqun Li, and Taylor LaJoie, “Details and Analysis of Democratic Presidential Nominee Joe Biden’s Tax Plan”, Tax Foundation, October 22, 2020, https://taxfoundation.org/joe-biden-tax-plan-2020/

2 Robert McClelland and Mark J. Mazur, “Permanently Extending the Tax Cuts and Jobs Act, President Trump would Cut Taxes by $1.1 through 2030”, Tax Policy Center, October 27, 2020, , https://www.taxpolicycenter.org/taxvox/permanently-extending-tax-cuts-and-jobs-act-president-trump-would-cut-taxes-11-trillion

3 Democrats.org, “Party Platform: The 2020 Democratic Platform”, October 15, 2020, https://democrats.org/where-we-stand/party-platform/

4 Rocky Mengle, “Election 2020: President Trump’s Tax Plans” https://www.kiplinger.com/taxes/601307/election-2020-president-trump-tax-plans

5 Stephen Liss, “Election 2020 Will Estate Planning Ever Be the Same?”,Law.com, Sptember 11, 2020, https://www.law.com/newyorklawjournal/2020/09/11/election-2020-will-estate-planning-ever-be-the-same/?slreturn=20200929173954

Filed under: Estate Planning

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