Election Year Estate Planning

Shearman & Sterling LLPSignificant tax reform could be imminent, depending on whether Biden or Trump wins next month’s election and which party controls Congress. Joe Biden’s tax plan proposes changes that would drastically impact wealth transfer planning, including, but not limited to:

  1. Reducing the Estate and Gift Tax Exemption. Currently, you can transfer up to $11,580,000 ($23,160,000 per married couple) during life or at death without incurring federal gift or estate tax. Transfers in excess of that exemption amount are subject to gift or estate tax at a rate of up to 40%. Biden has proposed retuning estate tax levels to “historical norms.” This could mean that, effective as of January 1, 2021, the estate tax exemption amount could be reduced to $3,500,000 ($7,000,000 per married couple), the gift tax exemption amount could be reduced to $1,000,000 ($2,000,000 per married couple), and the top gift and estate tax rate could be increased to 45%. Accordingly, your currently remaining gift tax exemption amount that is not used before yearend might not only be lost, but your future gifts might be subject to a higher tax rate.
    • Example: Assume you own a family business that currently has a fair market value of $11,000,000, and you have not used any of your gift tax exemption amount. If you gave the family business to your children in 2020, no federal gift tax would be due. If you made the same gift next year, assuming a $1,000,000 gift tax exemption amount and a 45% gift tax rate, you would owe $4,500,000 in federal gift taxes (45% x ($11,000,000 - $1,000,000)).
  2. Eliminating Basis Step-up at Death. Currently, for federal income tax purposes, the basis of inherited property is “stepped-up” to the property’s fair market value on the decedent’s date of death, effectively eliminating all capital gains on predeath appreciation. Biden has endorsed eliminating this benefit, however, it is unclear whether his proposal is to impose a tax on unrealized appreciation at the decedent’s death or to simply eliminate the basis step-up, so that inherited property would retain the basis that it had in the hands of the decedent.
    • Example: Assume you purchased stock in Company X many years ago for $25,000, and at your death, that stock has a fair market value of $2,000,000. Under current law, your heirs’ basis in the stock is stepped-up to $2,000,000 without any income tax consequences, and if your heirs eventually sell the stock, capital gains tax would be due only on any appreciation in excess of $2,000,000. If Biden is proposing to tax unrealized appreciation at death, a capital gains tax would be due on $1,975,000 at your death. If, instead, Biden is proposing to apply carryover basis, your heirs’ basis in the stock would be $25,000 and if the stock were sold, capital gains tax would be due on any appreciation in excess of $25,000.
  3. Increasing Tax Rate on Long-Term Capital Gains and Qualified Dividends for High Earners. Currently, the maximum federal tax rate on long-term capital gains and qualified dividends is 20%. Biden proposes to increase the top federal tax rate on long-term capital gains and qualified dividends to 39.6% on income above $1,000,000.
    • Example: Assume you earn over $1,000,000 annually and are considering selling your stock in Company X. As in the prior example, you purchased that stock many years ago for $25,000 and it currently has a fair market value of $2,000,000. If you sold this stock in 2020, the long-term capital gains tax due would be $395,000 (20% * $1,975,000 gain). If you sold the stock next year, assuming a 39.6% long-term capital gains tax rate, the long-term capital gains tax due would be $782,100 (39.6% * $1,975,000 gain).

The election is less than a month away, and its outcome could have significant implications for years to come. If you have not done so already, we strongly recommend that you consider planning strategies now, so that you are prepared to implement them prior to yearend. Please contact us if you would like our assistance in establishing a plan based on your individual circumstances.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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