Estate Tax Planning: Potential Post-Election Impacts to Consider
By Freddy H. Robinson, CPA, Partner
President-elect Biden campaigned on a series of sweeping changes to the tax code, aiming to levy higher taxes on high-income households and corporations, which includes overhauling taxes around wealth transfers.
Biden’s plan would reduce the amount that an individual can transfer free of estate and gift taxes from $11.58 million to $3.5 million in bequeaths at death and $1 million in lifetime gifts. His plan would also eliminate the step-up in basis, which allows heirs to receive assets valued as of the date of death. Instead, any unrealized capital gains would be subject to tax upon later disposition.
While Joe Biden may have won the presidency, that does not guarantee his gift and estate tax plan will become law. The catch is that the success of his plan depends on a “blue wave” in Washington. While Democrats have preserved their control of the House, two runoff elections in Georgia will determine whether there is a 50-50 split in the Senate. Once the results of those elections are known, we will have a better idea of the likelihood of Biden’s tax plan becoming a reality. Until then, we can only speculate and discuss the options to consider.
Estate taxes have affected fewer and fewer people over time. Only 1,900 of an estimated 4,100 estate tax returns were expected to have a tax liability in 2020, according to the Tax Policy Center. This is less than 0.1% of the estimated 2.7 million people expected to die this year. The percentage is so low because the federal government offers a generous estate tax exemption.
The gross value of your estate must exceed the exemption amount for the year of your death before estate taxes will come due. Even then, only the value over the exemption threshold is taxable.
The 2020 exemption is $11.58 million, up from $11.4 million in 2019.
The IRS announced in October 2020 that the estate tax exemption will increase to $11.7 million for tax year 2021. The exemption is indexed for inflation, so it tends to increase somewhat annually, even when tax legislation doesn’t affect it.
Current tax law also allows your estate to transfer any unused portion of your exemption to your spouse if you’re married at the time of your death. This provision is referred to as portability.
For example, you would have $5.7 million of your exemption “left over” in 2021 if your estate was worth $6 million and with the exemption set at $11.7 million. You could effectively give this portion of the exemption to your spouse, increasing his or her exemption by that amount when he or she passes away.
Should there be a reduction in the estate tax exemption, the two most important strategies for estate tax savings are:
- Removal of future appreciation from the donor’s estate
- Most importantly for high net worth families, a “use it or lose it” opportunity to transfer the maximum amount of assets based on the lifetime exemption amounts available under the current tax law
After careful consideration, if a decision is made to make non-spousal gifts to utilize the current lifetime exemption amount, it is just as important to determine what and how to make the contemplated gifts. In deciding what assets to gift, many factors need to be considered, such as:
- Asset cash flow
- Cash flow needs of the donor
- Asset basis (may not matter if step-up is eliminated)
- Donor or family voting control
- Long-term appreciation prospect of the asset
- Donor’s future financial uncertainty
One option for the structure of a lifetime gift to utilize lifetime exemption is for one spouse to create a Spousal Limited Access Trust (SLAT) for the other spouse. This method would transfer assets from one spouse into an irrevocable trust, but the grantor still technically has access. It would allow distributions to be made according to the terms of the trust.
The big benefit is that an individual would be able to use his or her lifetime estate tax exemption, which is $11.58 million. The current value of assets transferred and its future appreciation can be passed on without being exposed to the estate tax.
SLATs can also be set up to benefit children or grandchildren.
There are risks, however, including if a couple were to divorce or if the beneficiary spouse were to die before the grantor.
Similar to a SLAT, an intentionally defective grantor trust is an irrevocable trust that is usually set up to benefit either a spouse or future generations. Giving appreciated assets to the trust will not only unload them off of an estate, but it can also preserve the principle of the assets transferred.
An added benefit is that these plans are usually set up so that the taxes assessed on the income generated by the trust is paid by the grantor and not the children or grandchildren, which effectively results in an additional transfer of wealth.
If Biden’s plan prevails and Congress does change the estate tax laws, there is no way to know at this point what the effective date will be. Therefore, it is conceivable that the effective date could be January 1, 2021, so individuals should consider these impacts and whether or not to take immediate action.
If you have any questions or would like to discuss these matters further, please reach out to your tax advisor.
Freddy H. Robinson Partner, CPA
Freddy Robinson is a tax partner and has been with Bernard Robinson & Company for over 40 years. He is responsible for tax-related services to individuals and closely held businesses. His areas of specialty include complex income tax issues, Internal Revenue Service examinations, mergers and acquisitions, business valuations, succession planning, estates and trusts, S […]