Today’s Taxes or Tomorrow’s Turmoil?
by Arden Trust
Understanding how estate taxes might change in the future, and what to do about it now
A Special Insights Report by Michael Roberts, President, Arden Trust Company
If you’ve been following the financial and political news over the last several weeks, you already know there’s rampant speculation about what could happen if any or all of the American Families Plan proposed by President Joe Biden is enacted into law.
Financial professionals and their clients are scrambling to understand what it means for them and contemplating changes to financial and estate plans before anything is even debated or legislated.
Certainly, for high net worth investors estate taxes are important, but don’t sweat the details of what might happen to this tax in the future. In the realm of estate planning, it pays to focus on what’s most important: the interests of your loved ones.
The first and foremost reason to have an estate plan is to protect the natural objects of your bounty – to protect minor beneficiaries, or to protect adult beneficiaries from bad decisions, outside influences, creditor problems, and divorcing spouses. Or, as I like to say, from predators, creditors, in-laws and outlaws.
Part of creating a plan that reflects your wishes and address the concerns you have for your family and assets is, of course, tax consideration. We can only make decisions in today’s environment within the parameters of the laws and rules in place now, while keeping in mind that estate exemption amounts and rates are likely to change in the future.
The modern estate tax introduced into law in 1916 has changed dozens of times. The exclusion amount has risen from $60,000 at the end of World War II to $11.7 million today, and was never once been reduced during that time period. The top estate tax rate was 77% at the end of WWII and has slowly fluctuated downward to today’s 40%.
If the proposals being set out by the Biden administration in the American Families Plan are adopted, they could be historic in their scope and set the stage to change more than just estate taxes.
First, the plan omits (for now) President Biden’s campaign plan to raise the estate tax rate from 40% to 45% and lower the exemption from $11.7 million to $5.3 million.
There are also several proposals in the Senate, including Bernie Sanders’ For the 99.5% Act, that would lower the exemption to $3.5 million (as it was in 2009) and change the rate structure to 50% for estates over $10 million up to 65% for estates over $1 billion.
In addition, the American Families Plan would end a rule that has been a cornerstone of estate planning for generations of wealthy Americans: the step-up in basis for assets passing at death. The American Families Plan states that the proposed reform “will be designed with protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the business.”
Today, people who own assets that have boomed in value — stock in Apple or Google, the family home, cryptocurrency — don’t pay capital-gains taxes unless they sell. Under the Biden proposal, those unrealized gains would trigger taxes upon the owner’s death, minus a $1 million per-person exemption. More than two-thirds of all U.S. families have some unrealized capital gains, according to the Federal Reserve, but most would be covered by the $1 million exemption. For families in the top 10%, with a median net worth of $2.6 million, median unrealized gains are $519,000.
The taxation of previously untaxed gains would be a major change in federal tax policy, and one that would greatly complicate the administration of estates. Treasury Secretary Janet Yellen has stated that elimination of the step-up in asset basis at death is a priority for the Biden administration.
Finally, there are several technical adjustments not in the American Families Plan but contained in Biden’s campaign plans or other proposals. Three of the proposals would be relatively easy to enact.
One would end short-term trusts that allow people to pass tax-free to their heirs expected appreciation — say from the sale of a private business. Another would limit tax-free gifts that can be given each year to trusts to fund things like life insurance to pay estate taxes. A third would curtail special tax treatment that family partnerships receive, even when they own liquid securities and not an operating business.
So, what is the realistic probability that these changes become law?
I try not to overreact or be political when I give advice. I do think we will see a wave of tax code changes during 2021 all with an effective date of January 2022, because it generally takes that long to implement tax increases, which are complex to put into place and the lack of political will to impose new taxes in an economy still suffering from the impact of COVID-19. However, keep in mind that Congress has used various effective dates in recent tax legislation with no real standard for how to choose a date. Taxpayers could expect many provisions to be effective as of the date they were introduced into committee, the date President Biden signs the bill into law, or even retroactively to the first of this year.
Given the current deadlock in Congress, the most practical avenue to pass a tax law is through the budget reconciliation process, which would require all Democratic senators to support. I believe that there are enough moderate Democrats (Manchin, Warner, Sinema) that will likely demand modifications to the proposals in order to win their support.
We also don’t know the details and should wait until we see the Treasury Department’s Green Book, which is set to be released around Memorial Day. The scope and magnitude of all taxproposals (individual, corporate, as well as estate taxes) are aspirational and are unlikely to be enacted “as-is” given the legislative process and political considerations.
What should a high net worth individual do? Carefully consider their options, but try not to predict, when it comes to estate and gift taxes.
Given the current environment – both that the exemption is set to decease to $5 million in 2026 and the real possibility that the current administration will seek to reduce the exemption sooner and/or to a lower amount – we are currently in a situation where the exemption should be used, or it may be lost. Large gifts are a high-risk, high-reward planning opportunity, so here are some planning strategies to consider:
- Maximize your annual exclusion gifting before the law changes or the year ends.
- Fully use your lifetime gift exemption.1 Essentially, the current increased exclusion amount is a “use it or lose it” benefit.
- Consider funding a Grantor Retained Annuity Trust (GRAT) with appreciating assets.
- Create a Charitable Trust that pays you or your loved ones benefits while living.
Finally, do not procrastinate! If it appears unlikely that any estate tax laws will be passed this year, there will be a rush of individuals seeking to make large gifts toward the end of 2021. Most estate and trust law firms are already operating at capacity. If you have put your estate planning off for whatever reason, now is the time to get yourself into queue, get this done, and put your plan into place before any new laws may pass.
Learn more about planning strategies that could help you take advantage of estate and tax laws currently in place now.
1. The IRS has published “anti-clawback” regulations that provide if a donor who makes lifetime gifts when the increased exclusion amount is in effect and dies after 2025 when the increased exclusion amount reverts to the 2017 level of $5 million indexed for inflation, the excess will not be “clawed” back.
Arden Trust Company does not provide legal or tax advice. Please consult a legal or tax professional for advice specific to your circumstances.
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