With power transferring to the new Biden administration, taxpayers in the United States are likely to see many changes in the coming months. Biden’s tax plan included proposed changes to the current Estate Tax – and these changes are going to have a big effect on current estate plans.
The estate planning attorneys at Evolution Tax and Legal are breaking down the changes taxpayers can plan to see in the coming months and how you can take advantage of current Estate Tax laws before these changes go into effect. Read on for our breakdown and recommendations.
Current Estate Tax Laws
Estate Tax Exemption
Over the past twenty years, there has been a dramatic increase in the Estate tax exemption afforded to US taxpayers.
- In 2001, $675,000 of a US taxpayer’s was tax-exempt from the Estate Tax.
- In 2010, the Estate Tax exemption increased to $5 million per person.
- In 2017 under the Tax Cuts and Jobs Act, the Estate Tax exemption increased again to $10 million (adjusted for inflation).
- This means that in 2021, $11.7 million of a single US person’s estate is exempt from the Estate Tax.
The Rate of the Estate Tax
While the exemption amount has been increasing, the Estate Tax Rate has fluctuated.
- In 2001, the largest Estate Tax Rate was 55%
- In 2010, the Estate Tax Rate decreased to 35%
- Thereafter in 2013, the Estate Tax rate increased to 40%. The rate has remained the same ever since.
“Step-Up” in Basis
In addition to understanding Estate Tax exemption and rates, a benefit of the Estate Tax is that it provides the recipient of an estate’s assets as a ‘step-up’ in the tax basis of assets received to the assets respective fair market value upon death.
Thus, the ‘step-up’ in basis essentially allows recipients of estate assets to sell said assets without incurring taxable income because the fair market value of such assets now matches the same assets ‘tax basis’. In addition, the ‘step-up’ was geared to avoid the double taxation of inherited assets – taxed first by the Estate Tax and then again on the subsequent sale of the property.
For example, if someone purchased 10 shares of Tesla at $100 per share, the value at the time of purchase is $1,000. If, after 10 years, the value has increased to $5,000, their taxable gains would be $4,000. If, however, this person passes on and leaves their shares to an heir (e.g. child, sibling, etc.), the beneficiary inherits the shares with a ‘tax basis’ of $5,000. Thus, if sold at the time received, the beneficiary would recognize a $0 taxable gain (e.g. $5,000 FMV – $5,000 tax basis).
Alternatively, if the beneficiary rather decides to hold on to such share, which increases to $10,000 over the next couple of years, the beneficiary is only taxed on the capital gains accrued after they inherited the shares, which would be $5,000, instead of the $9,000 the original purchaser would be taxed on.
Estate Tax Changes Under Biden Administration
Biden’s tax plan is proposing to bring about big changes to Estate Tax as we currently know it.
Throughout the campaign, Biden proposed reducing the Estate Tax exemption amount to $3.5 million per person, a large decrease from the current $11.7 million per person.
Even if Biden’s proposal is not enacted as he has stated, the current Estate Tax exemption of $11.7 million per person is set to revert back to the original amount of $5 million per person (adjusted for inflation) beginning in 2026. There is little chance of the increased current exemption amount being extended, with the Biden administration in office and Democrats controlling the House and Senate.
Along with the decrease in the Estate Tax exemption, the new Biden Administration has proposed an increase in the Estate Tax Rate to 45%.
The most notable proposed changes to Estate Tax are surrounding surrounds the “step-up” in tax basis. The change would eliminate the ‘step-up’ in tax basis for assets inherited and would in effect create a double layer of taxation on all assets inherited – first by the Estate tax and the second, and again, on the subsequent sale of the inherited asset.
Who will be affected by the Changes in Estate Tax Laws
Whether you have a well-thought-out Estate Plan or you’re just beginning your Estate Planning journey, the changes to Estate Tax law will affect you and any beneficiaries you plan to pass on.
The combination of a hike in the Estate Tax rate, a decrease in the Estate Tax exemption, and the elimination of the ‘step-up’ afforded means that your future heirs will be on the hook for a large deal of Estate and income taxes.
In order to appropriately plan for the upcoming changes to the Estate Tax under the Biden administration, it is imperative that action be taken now and that your estate plan be reviewed.
Estate Tax Planning Strategies
In order to reduce future exposure to Estate Tax, reducing the size of the Estate is a beneficial practice. This can be done in a multitude of ways:
- Lifetime Gifting Strategies: The Gift Tax Annual Exclusion allows any person to give another person up to $15,000 per year, exempt from taxes. Thus, a strategy can be employed to set up annual gifting to reduce the size of your estate and provide your heirs with “early inheritances” tax-free.
- Expenses Paid on Behalf of Another: Another common strategy to reduce the size of an estate is to pay certain expenses directly to a third party on the behalf of another. This is relevant in cases such as college tuition and medical expenses and is a simple method to reduce the size of your estate and benefit your heirs during your life, all tax-free.
- Charitable Giving During Life and Upon Death: A person, during their life, can set up an arrangement whereby they gift on an annual basis, and upon death, gifts to a charitable organization of their choosing. Charitable donations during life and after death qualify as a deduction (for both income tax and estate tax purposes) and will reduce the size of your estate.
- Utilizing Currently Higher Estate Tax Exemption: The IRS and Treasury have released “anti-clawback” guidance whereby they have essentially approved US persons to utilize the currently higher Estate Tax exemption (e.g. $11.7 million in 2021) without it impacting the lower, Estate Tax exemption of $5 million per person beginning in 2026. This is to say, that US persons can make transfers and/or gifts of property (real or personal) to their heirs, during their lifetime, in excess of the annual gift tax exclusion, and avoid taxation by exempting such transfer through the use of the higher estate tax exemption of $11.7 million. Furthermore, should a US person decide to employ this strategy, and when the Estate Tax exemption reverts back to $5 million per person in 2026, said transfers and/or gifts of property will not be counted against the lower $5 million Estate Tax exemption. This, in effect, creates a temporary windfall for US taxpayers to take advantage of, and remove properties from their total estate during life.
- Complex Strategies: While beyond the scope of this article, there are many other complex strategies that can be employed to help plan your estate for the future that will otherwise reduce, mitigate, or eliminate the potential double-layer of taxation that Biden’s proposed Estate Tax reform will bring about–
- Irrevocable Life Insurance Trusts (ILITs);
- Family Limited Partnerships;
- Charitable Remainder Trusts (CRTs);
- Conservation Easements; and
- Many others depending on your personal situation.
Reducing the size of your estate through any means will help your future beneficiaries faceless taxes on their inheritance. No matter your situation it is necessary to speak with your estate planning lawyer and discuss your options with the upcoming changes to the Estate Tax under the Biden administration. Taxpayers need to take advantage of the higher exemption for estate planning, and that means speaking with your estate planner sooner, rather than later.
How Can Evolution Tax and Legal Help?
At Evolution Tax and Legal, we understand the intricacies of Estate Tax, and we can help you develop a short and long-term plan to take advantage of the current Estate Tax rates and exemptions. Speak with someone soon and make sure your estate plan is ready for the upcoming changes. Contact the tax attorneys Evolution Tax and Legal today.