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Estate and Gift Planning in Uncertain Times

By: Derek Gray, CPA, Director, and Chuck Mallick, CPA, Senior Manager

On the campaign trail, President Biden frequently mentioned significant changes to the estate tax. His proposals generally centered around three prongs: first, to raise the estate tax rate from 40% to 45%; second, to drop the lifetime exemption amount from $11.7 million to $3.5 million; and finally, to do away with the so-called “basis step-up” of assets upon death.

In late April, President Biden introduced The American Families Plan (AFP), which also addressed issues including job growth, educational reform, and additional stimulus to combat the COVID-19 pandemic. The AFP included some new proposals, and the President’s budget proposal has given us more detail on these new estate and gift tax proposals.

Current System

An estate pays inheritance tax at a rate of 40% on the excess of the fair value of assets held in the estate over any unused lifetime exemption. In general, the lifetime exemption is the amount that you can give away, either during your life or at death, without paying either gift tax or inheritance tax. Under current law, you can give away up to $11.7 million without paying gift or inheritance tax. Any unused lifetime exemption of one spouse can be “ported” to the surviving spouse to use during the surviving spouse’s lifetime, or at their death.

Additionally, upon your death, your heirs receive a step up in the basis of any assets held in your estate.

For example, let’s say that 20 years ago, you had the thought that this little online bookseller would one day completely change e-commerce, and you picked up 100 shares of Amazon at $16 a share, for a total investment of $1600. Currently, the stock is trading for somewhere around $3300 per share, meaning your total investment is worth $330,000 – a profit of $328,400. If you sell the Amazon stock during your lifetime, you’d pay tax on the gain. If you hold the stock at your death, however, your heirs step up the basis in that stock to the fair value on your date of death, meaning that $328,400 gain is never taxed.

Proposed Changes Included in the Budget Plan

The proposed budget includes a provision to make death a realization event, meaning you would pay capital gains tax on any unrealized gain for assets held at your death. Continuing with our example from above, if you held the 100 shares of Amazon at your death, the $328,400 gain would be realized at death and reported on the decedent’s final income tax return. This tax is in addition to, and does not replace, the inheritance tax. Any tax from these unrealized capital gains, however, would be allowed as a credit to offset inheritance taxes on the decedent’s estate tax return, if any are owed.

Similarly, any gift made during your lifetime would also be a recognition event. Under current law, if you own an asset with basis of $100 and a fair value of $1000, there is no tax to either the donor or donee if that asset is gifted. The donee simply takes the asset with a carryover basis and the gain is deferred until the donee disposes of the asset in a taxable transaction. The proposed law would end this treatment and cause recognition of a capital gain, which would be reported and taxed on the donor’s return, for the year in which the gift was made. Unlike transfers at death, there is no credit that appears to be given for any taxes paid on taxable gifts, either on a current income tax return or on a future estate tax return.

There are several exclusions that would apply to realization events and prevent tax from being paid for transfers at death or by gift: 

  • Spousal gifts (a gift from one spouse to another) would not give rise to a realization event. Instead, the basis would carry over from the donor spouse to the donee spouse and the unrealized gain would be taxed upon the death of the second spouse.
  • There would be no recognition on any gain related to tangible personal property upon death, such as household furnishings or personal effects, but excluding collectibles. In other words, there won’t be any gain on your couch or your clothes, but there could be on your jewelry, baseball cards or bourbon collection.
  • The gain on the sale of a primary residence would apply to all residences at death and allow exclusion of up to $250,000 per person on any residential properties.
  • The provisions of IRC Sec. 1202, which excludes the gain on sale for certain small businesses, would still apply.
  • There would be a $1,000,000 per person exclusion from recognition of unrealized capital gains when property is transferred by gift at death. This per person exclusion would be indexed for inflation after 2022 and would be portable to a surviving spouse.
  • Payment of tax on the appreciation of certain family-owned businesses would not be due until the interest in the business is sold or the business ceases to be family-owned and operated. Further, there would be a 15-year fixed-rate payment plan for the tax due on these family-owned businesses.

The proposed provision on estate and gift taxation would apply to transfers made after December 31, 2021.

Analysis and Commentary

So why has the Biden administration seemingly pivoted off its relatively straight-forward three-pronged approach to increasing estate taxes and pivoted to a tax on unrealized gains? We may never know for sure, but we can take some educated guesses.

First off, increasing the estate tax rate and lowering the exemption amount aren’t huge revenue raisers. Last year, the Tax Foundation estimated that proposal would only raise about $200 billion over a 10-year period (https://taxfoundation.org/joe-biden-tax-plan-2020/). Nothing to scoff at, for sure, but a drop in the bucket to an overall budget of $6 trillion. Some projections are estimating the new proposals could raise up to $400 million over the same 10-year period; however, the Tax Foundation is projecting roughly the same level of revenue from the new proposals as the old.

Secondly, it’s quite likely that Democrats aren’t as unified with these tax increases as the Republicans are against not raising them. With the Democrats controlling the House by such as small margin and the Senate being deadlocked, it’s possible that the Biden administration knew they were in for an uphill battle on certain tax increases. There are several Democrats who have stated publicly that they were against the repeal of the basis step up, so the proposals made on the campaign trail would have been difficult to pass into law.

Finally, it’s entirely likely that we haven’t seen the last of those campaign proposals and the Biden administration may come back for another bite at the apple in the future. Keep in mind, under the provisions of the Tax Cuts and Jobs Act, the lifetime exemption is scheduled to sunset back to pre-2018 amounts ($5.5 million, indexed for inflation) on 12/31/2025. In other words, even if the Biden administration is unsuccessful in passing any laws, the lifetime exemption amount will be cut in half in a few years. Could this be an attempt at a one-two punch of new revenue from these new proposals with some additional revenue coming from legislation that is already on the books?

While the proposals laid out in the Budget Plan differ significantly from those discussed on the campaign trail, they’re no less likely to receive pushback from most Republicans and even a few Democrats. There is no certainty that all or any of these proposals pass; in fact, it’s entirely likely any passed legislation looks different than what has been proposed. With all that in mind, what are we to do?

Planning Strategies

I have no idea if there will be any changes to the estate tax or gift tax regime. It doesn’t seem to have the support that say, raising the corporate tax rate does. However, I can’t just sit around and wait for legislation to pass to get started planning.

I’ve been meeting with many of my clients who have large estates or frequently make gifts to update them on what’s being discussed. Oftentimes, we’ll get their attorneys involved in these discussions as well. If you haven’t updated your estate plan in the last few years, now would be a great time to take another look.

I’m not advocating that you give away the farm now or put any plans into place just because of these proposals. More often than not, proposals like this are just a starting point and the end product looks very different. What I am advocating is that you meet with your advisors to discuss how these proposals might impact you. I’m a firm believer that it’s best to have the foundation of a plan in place now, just in case this legislation passes. Estate plans don’t come together overnight, even with a great team of advisors. If you wait until these proposals are on the verge of passing before starting to plan, it may already be too late.

Some of my clients are setting up new trusts or dusting off old trusts and trying to maximize the amount they put in while the lifetime exemption is still high. Others are willing to take a wait and see approach betting that the inflationary adjustments to the lifetime exemption will be enough to shelter their estate from tax. If you have appreciated assets that you know you’d like to give away in the next few years, it may make sense to accelerate that into the current year, but something as simple as that has to be viewed with an eye on whether or not you think the basis step-up will go away. Under the current tax regime, our goal is always to have a dollar less than the unused lifetime exemption in your estate when you die, and if those assets are highly appreciated, all the better!

In summary, this has and always will be complicated. In this environment, there’s an extra degree of difficulty because of all the uncertainty about what the future may hold. The good news is we’re here to help. If you have any questions or concerns, please reach out to the authors below or your local Blue & Co. advisor.

Derek Gray, CPA

Chuck Mallick, CPA
Senior Manager

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