Don’t let uncertainty regarding tax legislation blind you to the near certainty of profound changes – this year – and the need to protect your family’s inheritance.
To recognize where we are headed with respect to estate taxation, it is important to understand where we are now:
The current lifetime gift tax and estate tax limits have never been higher, and estates valued at up to $11.7 million per individual ($23.4 million per married couple) are not subject to estate tax.
An individual can reduce the value of their estate by gifting up to $15,000 per year per recipient, without reducing his or her $11.7 million estate tax exemption.
Estates that exceed the $11.7 million limit are subject to taxation at the rate of 40%.
For nearly four years we have known that those favorable numbers are not permanent. The 2017 Tax Cuts & Jobs Act has numerous sunset provisions, including the 2026 decrease in the gift and estate exemption from $11.7 million to $5 million.
The year 2026 was going to arrive too soon in the best of times, but the last 14 months hardly qualify as the “best of times.” The human and financial cost of Covid-19, combined with a decisive shift in the partisan makeup of Congress and the White House, has raised a renewed chorus of calls for the wealthy to “pay their share” of federal spending.
As a consequence, wealthy Americans – including hundreds of thousands of families that are now “wealthy” only by shifting standards and terminology – must brace themselves for 2021 passage of tax reforms that would:
accelerate the reduction in gift/estate tax limit, perhaps to as low as $1 million, and
abolish the use of trusts and other estate planning vehicles that leverage the exemption.
Here is a summary of three major estate/gift tax proposals:
President Biden’s American Families Plan.
The Biden Administration has proposed doubling the capital gains rate ( from 20% to 39%) and eliminating the “stepped-up income tax basis” at death. The latter provision, which the President has characterized as a “loophole,” allows heirs to sell inherited assets without capital gains tax.
Repealing that provision may prove to be an uphill battle, as the basis step-up “loophole” has been in the Tax Code for more than 100 years, and many tax and political considerations support its retention.
As a practical matter, it would be much easier to adjust the gift/estate exemption and/or tax rate. The President hasn’t yet suggested such changes, but the impracticalities of eliminating the basis step-up could cause him to pivot, to achieve his desired tax revenue and tax policy results. Along the way, he could fold into his plan some features of Vermont Sen. Bernie Sanders’ proposal.
Bernie Sanders’ “For the 99.5% Act.”
A very negative scenario for wealthy families and the biggest proposed change in the estate and gift tax in half a century, the Sanders plan would:
e exemption from $11.7 million to $1 million, effective January 1, 2022, and
rtually all of the strategies and vehicles (including GST dynasty trusts, IDGTs, GRATs, SLATs and FLPs) that leverage the gift limit and offer other tax-efficiencies – as of the date of enactment.
Affected taxpayers might find some solace in the grandfathering of trusts and other vehicles that are established and funded before the enactment date. However, enactment could occur this year, offering little time to implement well-conceived plan revisions.
Although there is a low probability of the Sanders bill becoming law (at least in its current form), many of its provisions mirror the gift and estate tax policies of the Obama era, when President Biden served as vice president. As was suggested above, it is possible that, if Congress rejects elimination of the step-up in basis as impractical, some elements of the Sanders bill could find their way into the ultimate legislation.
Van Hollen’s STEP Act.
Promoted by Maryland Sen. Chris Van Hollen, this bill seeks to treat any gift of appreciated assets, whether made during life or at death, as a “deemed sale” resulting in capital gains tax. (This is similar to Canada’s inheritance tax system.)
Most alarming is that this bill seeks to make the change retroactive to January 1, 2021.
This bill is not likely to pass for several reasons, including these:
re would be serious Constitutional challenges. Although there is precedent for retroactive tax changes, such changes have almost always benefited, not harmed, the taxpayer.
A large, unexpected tax due to gifting that preceded the law’s enactment would upset most wealthy constituents of lawmakers on both sides of the aisle.
ment would require a major overhaul of the U.S. tax system that would be difficult to administer.
Nevertheless, the Van Hollen STEP bill must be considered because of its disastrous tax consequences with respect to gifts made this year using appreciated assets.
Real Threat of 2021 Tax Reform
With Democrats holding a majority in the U.S. House of Representatives, the fate of gift/estate tax reforms will likely be determined in the Senate, where the biggest obstacle is the filibuster.
Breaking a filibuster requires 60 votes in the equally divided Senate, which would seem to make radical tax reform unlikely – except for a filibuster loophole. The “budget reconciliation” process allows for tax law changes to be passed with a simple majority (in the current partisan scenario, all 50 Democratic senators and the tie-breaking vote of the Vice President Harris).
Normally, this loophole can be used only once per federal fiscal year, which begins on October 1. It has already been used in the current year, to pass the American Rescue Plan and its $1.9 trillion in Covid-19 aid (notably, with no Republican support in the Senate).
However, in April the Senate’s parliamentarian ruled that the Senate can “piggyback” and amend the recent March 2021 budget reconciliation to make additional tax changes – in other words, allowing for this loophole to be used twice in the 2020-2021 fiscal year.
If that attempted piggyback fails, on October 1 of this year the Senate will have a fresh fiscal year to enact 2021 tax reform.
In short, during 2021 Senate Democrats could have multiple opportunities to pass tax legislation without a single Republican vote, making some measure of tax reform this year virtually inevitable – especially with the need for additional tax revenue to pay for all of the Covid-19 relief and other spending priorities.
Narrowing Window of Opportunity
If your estate would be adversely affected by any of the tax reform proposals described above, you would be wise to initiate action now, forearmed with the following.
As we mentioned earlier, the Sanders proposal allows for grandfathering of all trusts and other planning vehicles that are established and funded before the new tax law goes into effect, sometime this year.
With that in mind, note that a 2019 IRS ruling states that, if you gift your $11.7 million exemption before it is reduced (due to tax reform or otherwise), you will “lock in” your exemption, and it will not be forfeited. In other words: Use it (before tax reform goes into effect), or lose it.
In light of that IRS ruling, and in anticipation of a January 1, 2021, reduction in the exemption, last year most sophisticated estate planning attorneys were urging their wealthy clients to gift their $11.7 million exemption to trusts. Many clients took our advice; some did not.
Circumstances have left open a window for action, but, as we saw in late 2020, law firms and CPA firms will be forced, at some point, to close their doors to new clients seeking to set up trusts to preserve their exemption.
. If your net worth exceeds $10 million (including the value of business interests, life insurance, IRAs, real estate, etc.), you should seriously consider immediate action to establish a well-designed irrevocable gift trust – now, before the rush, and while the opportunity exists.
Although the trust “shell” should be created as soon as possible, some clients are waiting a few months before actually funding the trust (making the gift), in hopes that they will have maximum clarity regarding tax law changes.
This process requires thoughtful planning and enough lead time (three to 12 weeks, depending on your situation and your attorney’s workload) to accommodate all aspects of document preparation and plan execution.
To start the process, contact your
Frazer Ryan or Whetstine Law Firm estate planning attorney
Senate Estate and Gift Tax Bill Will Reduce Exemption to $3,500,000 and Take Away Many Opportunities
” (Alan Gassman),
, March 27, 2021
Biden’s Capital-Gains Tax Plan Would Upend Estate Planning by the Wealthy
” (Richard Rubin and Rachel Louise Ensign),
The Wall Street Journal,
April 29, 2021
How the Wealthy Are Trying to Anticipate Biden’s Tax Increases
” (Paul Sullivan),
The New York Times,
May 6, 2021