The possibility of tax changes impacting estate planning substantially increased following the recent Georgia runoff election. After January 20, the Democrats will control the House of Representatives, Senate (with Vice President-Elect Harris’ tie-breaking vote as President of the Senate), and White House. Although Democratic control of all three branches of the federal government could result in several changes to existing tax laws affecting estate planning (e.g., potential increase in individual and business income tax rates, elimination of the “step-up” in income tax basis on death, etc.), this update focuses on possible changes to the lifetime federal estate, gift, and generation-skipping transfer tax exemption amounts, related tax rates, and the anticipated date of any such changes.
The current lifetime federal estate, gift, and generation-skipping transfer tax exemption amounts (amounts individuals can transfer free of estate, gift, and generation-skipping transfer tax over the course of his or her lifetime or at death) are $11.7 million per person ($23.4 million per married couple). These exemptions are the highest they have been since the modern estate tax was implemented in 1916. Transfers during lifetime or at death in excess of the above exemption amounts are currently taxed at a rate of 40%.
Although the current exemption amounts were never intended to be permanent (currently scheduled to be cut almost in half to about $6 million in 2026), the likelihood that exemption amounts will be substantially reduced greatly increased after the Georgia runoff election. Now that the Senate is split perfectly between parties, Vice President-Elect Harris is expected to cast any tie-breaking vote in a party-line Senate vote, which could reduce the exemption amounts. Vice President Cheney cast a similar tie-breaking vote that pushed through tax changes when the Jobs and Growth Tax Relief Reconciliation Act passed in 2003.
President-Elect Biden has proposed reducing the exemption amounts from $11.7 million to as low as $3.5 million and increasing the tax rate from 40% to 45% which translates to almost $4 million of additional tax on impacted individuals.
If legislation is passed in 2021 to reduce the exemption amounts and increase the tax rate, three possible effective dates for such legislation might be: (1) retroactive to January 1, 2021; (2) immediately upon enactment (or retroactive to date legislation introduced in Congress); or (3) prospective to January 1, 2022.
The U.S. Supreme Court has indicated that a retroactive change in tax law will be respected if the change is rationally related to a legitimate legislative purpose. Raising revenue to address historic pandemic spending likely satisfies this requirement. Although a retroactive reduction in the exemption amounts from $11.7 million to $3.5 million and an increase in the tax rate from 40% to 45% would likely survive constitutional challenge, tax commentators have indicated that the harsh effect and perceived unfairness make it unlikely that a retroactive change effective January 1, 2021, would occur.
Some tax provisions are effective immediately or as of the date the provision was introduced in Congress in order to limit taxpayer ability to plan around the change.
Our review of the legislative history of laws impacting the exemption amounts indicates that the vast majority of such laws are enacted with an effective date of January 1 of the following calendar year.
If you anticipate having an estate in excess of the $6 million 2026 exemption amounts (or $3.5 million if concerned about paying tax under President-Elect Biden’s tax proposal), we suggest you consider strategic gifting of assets outright or in trust now, while the exemption levels are still at their historic high. We are happy to suggest some techniques to reduce or eliminate the adverse effect of retroactive decreases in the exemption amounts. We suggest that any such strategic gifting occur sooner rather than later in order to avoid losing the ability to use the high exemption amounts to make such gifts.