Based on the tax plan proposed by President-elect Biden, the federal estate and gift tax (and generation-skipping transfer tax) exemption might be reduced from its current amount of $11.58 million to a level that predates the 2017 tax law changes. The exemption, which is set to increase to $11.7 million in 2021, could be reduced to $5.6 million, plus inflation, or possibly as low as $3.5 million. The estate tax rate could also be raised from the current 40 percent to prior rates, such as 45 to 55 percent under the 2001 Tax Act. Tax law changes could also include elimination of valuation discounts, which have been a target before. In any case, even with no affirmative change, the exemption is scheduled to be reduced automatically to approximately $5.6 million, as adjusted for inflation, on January 1, 2026. Income and capital gain tax rates could go up in a new Administration and may rise at the state and local level as well.
Gifts. As we noted in a recent alert (see here) there are compelling reasons to consider accelerating your estate plan through 2020 lifetime gifts: (1) the federal gift tax exemption this year is $11.58 million, effectively double that for a married couple ($23.16 million), (2) none of Idaho, Oregon, or Washington imposes a gift tax at the state level, (3) if there is a change in the law next year, it could be made retroactive to January 1, 2021, and (4) the IRS has provided guidance that it will not seek to “claw back” gifts sheltered with higher exemptions if the exemption decreases in the future. We also addressed other benefits of making gifts to use the current high gift exemption before any possible change in the law (see here).
The proposed reduction of the gift and estate tax exemption would be likely only if the Democrats control both houses of Congress in addition to the presidency. Control of the Senate will not be decided until the Georgia runoff election in early January. A Republican-controlled Senate is unlikely to vote in favor of as large a reduction as the Biden plan contemplates. It is possible, however, that a majority of senators would negotiate a comprehensive bipartisan tax bill that would include some reduction in the exemption, perhaps in response to pandemic and recession-related stimulus spending.
Gifts offer a tax-efficient way to decrease one's eventual transfer tax liability. Not only do gifts prevent future appreciation from being subject to an eventual estate tax, the way in which gift taxes are calculated results in a lower tax liability than if those assets were instead subject to estate taxes. Moreover, many states that have an estate tax, like Washington and Oregon, do not impose a gift tax, allowing gifted assets to avoid state transfer taxes. As a result of these factors, the sooner a gift is made, the more valuable the tax advantage. When making a gift, it is important to consult with your legal, tax, and financial advisers to understand the appropriate assets to gift and the recommended strategies that best fit your particular profile (regarding control and needs for current income and/or future liquidity).
If it would not be an economic hardship for you to use the current exemption, we still believe it makes sense to do so as soon as possible, particularly if you are in Oregon or Washington, which have state estate (but not gift) taxes. Another reason to act now is to give yourself enough time to open new accounts that may be necessary as a result of creating new trusts. Many investment firms are issuing dates by which accounts must be funded. Since gifts must be funded by the end of the year, we recommend that you contact your financial institution for deadline information. For those of you who are on the fence about whether to use the exemption because of your situation, we suggest a discussion with your estate planner and tax and financial advisers.
Roth Conversions. We anticipate that federal income tax rates could rise under a new Administration, and that state income tax rates will likely rise in many jurisdictions as well (see here for our recent alert about Oregon taxes). Income tax rates may be lower now than in the future. You may want to discuss with your financial advisers and accountants whether now might be a time to convert your IRA to a Roth IRA. Converting an IRA to a Roth results in a large tax hit in the year of conversion, but thereafter the assets in the Roth IRA grow tax free. This is most attractive if you plan to leave your IRA to your family at your death, as opposed to spending it down in retirement or leaving it to charity. Your financial adviser can run analyses to show the benefit of after-tax growth over a number of years. Please be aware that recent changes in the law now prevent you from “stretching” the Roth payments for the lives of your children or grandchildren.