Over the last six months, President Biden has communicated some of the potential tax law changes he considers important. He has also recently sent the American Families Plan1 to Congress, which formally proposes many of his previously mentioned changes. A review of those proposed changes and other tax provisions floated by the Obama Administration and current Democratic Senators will hopefully shed some light on what tax changes may be on the horizon.
Estate and Gift Tax Exemption
Under current law, the estate and gift tax exemption is $11.7M per person or $23.4 million for a married couple. While it was not included in the American Families Plan, President Biden has stated that he supports lowering the estate tax exemption to either $3.5 million or returning to the pre-Tax Cuts and Jobs Act (TCJA) limit of $5.5 million. He has also indicated an inclination to lower the Generation-Skipping Transfer Tax (GSTT) exemption from the current $11.7M to $1M. During his campaign, President Biden also proposed raising the current top estate tax rate from 40% to 45%.
There has been no mention of changing the annual gift exclusion amounts. However, the proposals would provide a total limit on annual exempt gifts to one trust or to all donees of $30,000 to $50,000.
Elimination of Stepped-Up Basis
Currently, heirs of an estate receive assets with a basis equal to the fair market value of those assets at the time of the decedent’s passing. This essentially eliminates any capital gains tax on the unrealized gains embedded in an asset prior to the date of death. President Biden has proposed in the American Families Plan eliminating this "stepped-up" basis rule. His proposal would subject estates to capital gains tax - in addition to estate taxes - on assets with unrealized gains regardless of whether the assets are sold.
Elimination of the Preferential Capital Gains Tax Rate
Beginning with the Revenue Act of 1921, Congress has frequently tinkered with the tax rates on the sale of capital assets. Part of President Biden’s proposed American Families Plan is an increase to the capital gains tax rate for taxpayers with income over $1,000,000. Those high-income taxpayers would pay 43.4% on long-term capital gains.
Other Potential Changes
- Increase in the Highest Ordinary Income Tax Rate – Currently, the highest tax bracket for individuals is 37%. The American Families Plan would increase the rate to the pre-Trump level of 39.6%.
- Higher Estate Tax Rate – One provision that has frequently been floated by the President but was not included in the American Families Plan, would impose a higher estate tax rate for large estates such as 40-50% for estates valued at $3.5 million to $1 billion and a 77% rate for estates in excess of $1 billion.
- Irrevocable Grantor Trusts - One of the more widely used estate planning devices is an irrevocable grantor trust that allows for the trust’s income to be reported on the grantor's income tax return. These trusts are popular as they frequently have lower tax consequences, are easier to administer, and provide the most value to the beneficiaries. The potential tax law change would disallow trusts that both remove assets from the grantor's estate while also allowing the grantor to pay the income taxes generated by the trust's assets.
- Limitation of Like-Kind Exchange Rules – A recent request by President Biden to help fund the American Families Plan would be to limit deferred gains from Section 1031 Like-Kind Exchanges to a maximum of $500,000.
- Elimination of Discounted Rates - Proposals could eliminate the 20-40% discount commonly taken on assets transferred to family-held limited liability companies and limited partnerships.
- Grantor Retained Annuity Trust (GRAT) Minimums - Proposed changes include creating a minimum term for a GRAT, which could increase the likelihood the GRAT terminates before the transferred asset(s) appreciate materially or increase the overall amount that is returned to the estate through annuity payments. Another proposal would require a minimum taxable gift to be generated by the GRAT creation (such as the lesser of 25% of the transferred amount or $500,000).
- Generation-Skipping Tax (GST) Changes – Proposals have been put forth to eliminate the GST exemption for dynasty trusts, including subjecting trust assets to the GST tax after 50 or 90 years. A dynasty trust is a tool that allows for assets to accumulate across multiple generations without being subject to the estate tax at each generation.
- Conservation Easement Deduction Increase - The potential tax change would be to increase the estate tax deduction for the creation of conservation easements from the current $500,000 to $2,000,000.
With the wide variety of possible changes and the unknown timeline for enactment, clients with a potentially taxable estate are left wondering what, if anything, to do. These are complex topics and there are no one-size-fits-all planning solutions. We will continue to monitor the timeline and outcome of all these potential tax changes that could affect our clients’ financial plans. We thank our clients for their trust in us.
If you have questions about any of the potential tax changes above or about your estate and financial situation, please reach out to your Counselor or contact us here to learn more about working with a GW & Wade Counselor.
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