Potential Tax Law Changes That Would Affect Estate Planning

[Please note:  This post is shared and intended to be for informational estate planning purposes only for those who may be affected by potential tax law changes.  It is not intended to be an endorsement for one political party candidate or the other.]

The 2020 election is almost upon us. The past has taught us that trying to predict the results of an election are futile at best. Still, estate planning clients need timely counsel as to how the election may impact their financial futures. Estate planning attorneys strive to help clients stay informed and suggest opportunities for clients to respond to changes. While we do not know exactly what the future holds, we do have strong clues as to what the tax laws may look like if the balance of power shifts in 2021 from Republican to Democrat hands.

Note that these changes are not necessarily dependent on the outcome of the November election. Some commentators suggest that even under a continued Republican-controlled government, many of the changes discussed below could be implemented as the nation grapples with the economic pressures brought about by the coronavirus pandemic.

Here is what we know so far about some of the key proposals most relevant to estate and tax planning:

The Tax Cuts and Jobs Act (TCJA), signed into law by President Donald Trump on December 22, 2017, doubled the basic exclusion amount from $5 million to $10 million, indexed for inflation. In 2020, the estate and gift tax exemption is set at $11.58 million with any wealth transfer exceeding that amount being taxed at the top rate of 40 percent. The generation-skipping transfer (GST) tax exemption currently matches the estate and gift tax exemption. Under the TCJA, the basic exclusion amount is scheduled to reset back to $5 million in 2025 (indexed) unless new legislation is passed before then.

Former Vice President Joe Biden has suggested that if elected President, he would support legislation that would reduce the estate and GST tax exemptions to $3.5 million and would lower the lifetime federal gift tax exemption amount to $1 million. In addition to reduced exemption amounts, a number of Democrat proposals have discussed returning estate tax rates to “historical norms”: In 2001, estate tax rates were as high 55 percent, with an additional 5 percent for estates over $10 million. If a new Congress looks back two decades or more for transfer tax inspiration, it seems likely that we could see an upward adjustment in the transfer tax rates.

Under the current law, capital gains are taxed as ordinary income if those gains are realized on property held for less than one year. For long-term capital gains (gains on property held for a year or longer), there is a graduated tax rate (zero percent, 15 percent, and 20 percent), depending upon the taxpayer’s income bracket. Taxpayers who earn income from investments may be subject to a 3.8 percent net investment income tax on the lesser of their net investment income, or the amount by which their modified adjusted gross income exceeds $125,000 (married filing separately), $200,000 (single or head of household), and $250,000 (married filing jointly), in addition to the applicable capital gains tax rate.

Current law also allows for a step up in basis on appreciated property if held until the owner dies. This allows for inherited property to be sold or liquidated shortly after the death of an individual with little to no capital gains tax on the sale.

Today’s law also allows for like-kind exchanges on appreciated property such as artwork and rental properties, enabling taxpayers to reinvest the gains earned on appreciated property into similar types of property without having to pay capital gains taxes when the property is later sold. If an individual makes subsequent like-kind exchanges on appreciated property until that individual’s death, then the capital gains built up in that property will be erased by the basis step-up rules.

Proposed changes under a Biden presidency would either (1) eliminate the step-up basis rule for inherited property and impose a carryover basis rule for inherited property, or (2) impose recognition of gain on property at the death of the owner. Additionally, the Biden tax plan proposes to eliminate like-kind exchanges and impose a 39.6 percent long-term capital gains tax rate on individuals earning more than $1 million per year. If the law retains the 3.8 percent surtax on net investment income discussed above, the effective federal tax rate on long-term capital gains could reach over 43 percent.

If these capital gains and estate tax changes are implemented, many estates could see significant tax bills at the decedent’s death.

The likelihood and timing of any of the proposed changes is uncertain, but it is important to know of the potential changes to avoid being taken by surprise.

Next week, I will discuss estate planning strategies to consider in light of theses possible changes.

-Jon