Capitol Building in Washington, DC
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Estate planning attorneys were inundated at the end of 2020 with year-end gifting. Many people felt that with Biden in the White House and the possibility of Democrats controlling both houses of Congress, the Trump-era tax reforms would be rolled back. In particular, the concern was that Democrats would reduce the estate tax lifetime exemption (currently set at $11,000,000, adjusted for inflation).
The concern was justified. Democrats won both Senate seats in Georgia that were up for grabs in a January runoff election. Republicans and Democrats each now have 50 seats in the Senate with Vice-President Harris giving Democrats the advantage as the tie breaker.
President Biden enters the White House during a historic and challenging time. Donald Trump’s impeachment trial in the Senate is looming, while the coronavirus continues to wreak havoc on our country with over 420,000 deaths so far. Many people are out of work and cannot meet mortgage and rent payments, let alone put food on the table.
Needless to say, tax reform is not at the top of President Biden’s agenda. In his inauguration address, the President called for unity and for getting control of the pandemic. His message was clear. He is on a path to heal our divided nation and get people vaccinated.
Given those two priorities, it is unlikely that tax reform will be next on President Biden’s agenda. Also, keep in mind that most legislation requires 60 votes in the Senate to pass. In order to pass tax reform, Democrats will need some Republican support and they will have to keep the support of moderates in their own party.
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The possibility exists that tax reform could pass late in 2021 but be retroactive to January 1. While that is possible, most tax advisors feel that scenario is unlikely.
If tax reform does come in 2021, many think it will happen toward the end of the year and be effective in 2022. Once the vaccine has been widely distributed, Americans are back to work and the nation begins to heal, someone is going to have to pay for all the COVID relief that the government has been providing. Some form of compromised tax bill may be in the future. Here are five ways that tax reform may affect your estate planning:
• Estate tax exemption – If Congress does nothing to change the tax laws, the current $11 million lifetime exemption amount (adjusted yearly for inflation) afforded by the Trump era changes is scheduled to expire on December 31, 2025. The amount will then drop back down to $5 million (also adjusted for inflation). We do not know what amount Biden will advocate for as his campaign website did not actually state his proposal for a new estate tax exemption amount. However, the Tax Policy Center estimated that Biden’s plan would reduce the exemption to $3,500,000.
• Estate tax rate change – The current estate tax rate of 40% could increase. In 2001, it was as high as 55%.
• Lowering the gift tax – Currently, the estate and gift tax exemption amounts are the same ($11 million, adjusted for inflation); however, the possibility exists that the gift tax exemption amount will be lowered to $1 million.
• Elimination of the step-up in basis at death – Many people with a highly appreciated asset such as stock will not sell it during their lifetime to avoid paying a capital gains tax. Instead, they pass it to their heirs at their death. The heirs will then receive a step-up basis of the asset’s value. If the heirs turn around and sell the asset right away there is no gain on the sale and therefore no capital gains tax to pay. However, an elimination of the step-up in basis at death would mean that the heirs would have to pay capital gains tax on the inherited property.
• Potential increase in capital gains rate – Biden’s proposed tax plan recommends increasing the long-term capital gains tax rate to the level of ordinary oncome for those people making over $1 million annually.
While the new year is just getting started, it’s not too early to start thinking about how these potential major tax reform changes might impact your estate planning.