First, the Biden Administration has proposed significantly reducing the current gift and estate tax exemption, which will result in increases of gift and estate tax imposed on large estates. Second, a proposal to eliminate the “step-up in cost basis” benefit for taxpayers on assets at death, which will result in more capital gain taxes being paid when those assets are sold.
The IRS imposes tax on certain gifts made during life and property transferred at death. Gifts during life are subject to gift tax when total gifts are made over certain amounts to non-spouses and must be reported to the IRS. At death, an estate may be subject to estate tax (death tax) if the date of death value of the taxable estate exceeds limits set by the government for lifetime gift and estate tax exemptions. The death tax itself is heavily criticized by taxpayers because it is a tax imposed on money or assets that the taxpayer has already paid taxes on during life.
The Tax Cuts and Jobs Act of 2017 (“TCJA”) temporarily increased the gift and estate tax exemption limits, resulting in a tax benefit to estates by decreasing the tax liability of many estates. The 2021 gift and estate tax exemption is $11.7 million per person. The TCJA was written to adjust the exemption amount for inflation each year until 2025, at which time the exemption will be reduced, adjusted for inflation down to the pre-TCJA amount of $5.49 million per person.
The Biden Administration proposed decrease of exemptions to $3.5 million per person is much lower than the pre-TCJA amount. This decrease will cause many more decedent estates to pay death tax. The Biden Administration also proposed an increase in the top tax rate to taxable estates from 40% to 45%. If approved, the decrease in exemption combined with the increase in top tax rate will subject many more decedent estates to increased tax liability if the estate value is more than a few million dollars. It is unknown whether this proposal would apply retroactively to the beginning of 2021. In the past, changes in the exemption amount have not been applied to already completed transfers. Planned giving strategies are difficult when there exists uncertainty in tax law.
If the proposal to eliminate the step-up in cost basis for capital gains tax is approved, there will be a negative effect to beneficiaries receiving assets after a death. At present, a beneficiary’s tax basis on inherited property is generally increased or “stepped-up” to the fair market value of the asset on the date of the decedent’s death. (During life, if an asset is sold for a profit, capital gains tax is applied on the difference of the purchase price to the sold price.) With a step-up in basis on an asset to the date of death value, there is a powerful tax benefit to the beneficiary inheriting the asset. When the beneficiary later sells that asset, the capital gain tax is then based on the difference between the sale price the beneficiary received and the stepped-up basis on the asset form the date of death value of the decedent. The beneficiary’s tax burden is reduced due to the step-up in basis to date of death value.
If the step-up in cost basis is eliminated, a beneficiary who inherits an asset that has appreciated in value during the decedent’s lifetime will have to pay much higher taxes when the asset is eventually sold. People who anticipate that beneficiaries will inherit assets with substantial likely appreciation in value should consider utilizing estate planning tools to help mitigate this potentially significant tax increase.
It is impossible to yet know if these two Biden Administration proposals will become law during 2021 or whether these proposals, made during the 2020 election campaign, will change in substance before submitted as proposed legislation. The timeline of any tax law changes cannot be known for certain, especially in view of the current COVID-19 pandemic and economic crisis. These proposed tax law changes, and others likely to come, may impact your estate planning. For 2021, it is important to stay updated on any proposed tax law changes and to discuss them with your estate and tax planning attorneys, along with your other trusted advisors.