There is a strong possibility that 2021 will see significant changes to our tax laws. The Biden Administration and various Democratic legislators have proposed a variety of changes to our system of taxation for corporations and individuals. It is difficult to predict which of these proposals will be adopted or in what form, particularly with the slim majorities the Democratic party holds in the House and the Senate and the complexity of tax legislation. However, it is probable that some changes will be made. The purpose of this article is to summarize the possible changes to tax laws that impact estate planning clients and to recommend possible actions.
Some potential legislative changes are as follow:
- An increase to the 40% estate tax rate to a range of 45% to 77%.
- A reduction of the estate tax exemption amount (currently $11.7m per person) to $3.5m-$5m per person.
- The reduction of the gift tax exemption amount to as little as $1m per person (as recently as 2009 the gift tax exemption was less than the estate tax exemption, which is meant to discourage lifetime gifting).
- A limit on the amount of time a trust can exist without being subject to a generation skipping transfer tax (currently, there is no time limit, which is one of the significant benefits of “Dynasty Trust” planning). For example, one proposal is to apply the tax every fifty years.
- Elimination of the “basis step up” for appreciated assets at death. Currently, most assets get a basis step up to date of death fair market value upon death. It is possible that the step up would not be completely eliminated and instead there would be a $1m cap on basis to allocate and perhaps gains of less than $100,000 would be exempt.
- In conjunction with no basis step up, there would be a deemed sale of assets at death, thus triggering a capital gains tax to the extent the value of assets exceeds actual cost basis or the amount allocated at death. This proposal is particularly important if the capital gains rate is increased and will greatly impact family business owners and anyone that owns real estate. The deemed sale rules may also apply to gifts.
- Limitations on the use of irrevocable grantor trusts, including the time frame for the term of a Grantor Retained Annuity Trust (typically, a GRAT has a two-year term and there is a proposed minimum term of ten years).
Given the uncertainty of the tax laws, it is important to review your estate plan to ensure it carries out your intent in a tax-efficient manner. Some planning options to consider depending upon your circumstances:
- Create a “Spousal Lifetime Access Trust”, which is an irrevocable trust that benefits a spouse for his or her lifetime. The spouse can serve as the trustee. The funding of this trust would utilize your gift tax exemption amount. The trust can be structured to benefit your children as well as your spouse.
- Create an irrevocable trust that benefits children, grandchildren, and other descendants.
- Outright gifts.
- Funding 529 Plans.
- Clients with large taxable events (such as the sale of a business this year) may consider charitable planning techniques, such as a Charitable Remainder Trust or Charitable Lead Trust (these trusts provide you with an income tax deduction but also benefit your family). Other clients may want to defer significant charitable giving until future years when the charitable income tax deduction perhaps is more valuable due to higher tax rates.
It is important to periodically review your estate plan regardless of the legislative environment. However, in the current environment it is particularly important to make sure your plan maximizes the benefits of the tax laws.