Estate and Income Tax Changes under a Biden-Harris Administration
With the 2020 general election results in, the Joe Biden and Kamala Harris tax plan has the potential to have important implications on taxes in the future. The likelihood that and extent to which changes to the tax code will occur under a Biden-Harris administration will depend largely on whether Republicans retain a majority in the Senate or Democrats gain control of both chambers of Congress. We will not know the outcome of the Senate race until after January 5, 2021, when the Georgia senatorial runoff elections are complete. The Democrats are expected to retain control of the House. Regardless of the result in Congress, what we do know is the following:
- The current estate tax exemption is set to “sunset” back to pre-2018 levels at the end of 2025; and
- Interest rates are at an all-time low. The Federal Reserve recently voted to keep short-term borrowing rates at a range between 0% and 0.25%.
Therefore, planning ideas are important even with the continued uncertainty in Congress.
A. Potential Estate Tax Changes
Proposed Reduction of the Federal Estate Tax Exemption
The federal estate tax exemption (or unified credit/lifetime exemption) is a threshold amount for filing an estate tax return and paying a federal estate tax. If a decedent’s gross taxable estate is below the federal exemption amount then it is not necessary to file a federal estate tax return or pay any federal estate tax. Currently, the exemption amount fluctuates every year based on inflation. In the 2000s, the exemption amount steadily trended upward from $1.5 million in 2005 to $5 million in 2011 to $5.45 million in 2016. The exemption roughly doubled in 2018 as a result of the Tax Cuts and Jobs Act. The current exemption in 2020 is $11.58 million. The Biden-Harris tax plan proposes reducing the federal exemption amount to $3.5 million (returning it to the 2009 level) and increasing the top rate for the estate tax to 45 percent (currently 40 percent in 2020).
Even if the Biden-Harris tax plan is not passed, the current estate tax exemption is set to expire on December 31, 2025. This would bring the federal estate tax exemption down to approximately $6 million (indexed for inflation). This is around half of what the exemption is today. Luckily, there is still time to plan and Congress has stated that individuals who take advantage of the current exemption while it is in place will still be able to maintain that advantage if the tax exemption sunsets. Therefore, now is a great time to start thinking about planning opportunities to save estate taxes.
B. Potential Income Tax Changes
Proposed Removal of Step-Up in Cost Basis at Death
The cost basis of an asset is generally its value when it is purchased, plus any material improvements made to the property, if applicable. When the asset is sold, its gain or loss for tax purposes is the difference between its value when it is sold and its cost basis. Under current tax rules, when a person dies the cost basis of the decedent’s asset is adjusted (“stepped up”) to the value of the asset as of the date of death. Since the value of an asset often increases over a person’s lifetime, this step-up in basis rule has the opportunity to significantly reduce taxable gains on inherited assets. The Biden-Harris tax plan proposes to remove the step-up in cost basis at death and enact an income tax on the unrealized gains of the asset.
Other Proposed Tax Changes
There are a myriad of other proposed changes in the Biden-Harris tax plan designed to raise revenue and benefit low income and middle income Americans. Such tax changes may include:
- Increasing the top federal individual income tax rate (for those earning more than $400,000) to 39.6 percent (currently 37 percent).
- Increasing the capital gains tax rate on individuals earning more than $1 million to the ordinary income tax rates, up to 39.6 percent (currently 20 percent).
- Limiting itemized deductions for those earning more than $400,000 to 28 percent.
- Imposing a 12.4 percent payroll tax on income earned above $400,000 (split between employers and employees).
- Increasing the corporate income tax rate to 28 percent (currently 21 percent).
C. Responding to Potential Estate Tax Changes
There are several steps that individuals can take now to utilize their current lifetime exemption before a new tax plan is in place and to take advantage of the low interest rates. The simplest one is to make lifetime gifts of up to the current lifetime exemption. Currently, in 2020, an individual can give up to $15,000 per person per year and a married couple can give up to $30,000 per person per year. Additionally, an individual can pay an unlimited amount of medical or tuition expenses for another completely gift tax-free. Depending on which state you live in and the value of the gifts, you may need to file a gift tax return and pay gift tax on those transfers.
A few more complicated options for using up the lifetime exemption are as follows:
- Spousal Lifetime Access Trust (SLAT);
- Qualified Personal Residence Trust (QPRT);
- Grantor Retained Annuity Trust (GRAT); and
- Charitable Remainder Trusts.
A SLAT is an irrevocable trust created by one spouse for the benefit of a group of beneficiaries that includes the other spouse. The trust is funded with the donor spouse’s lifetime exemption while both spouses are alive. To learn more about the advantages and disadvantages of SLATs see – SLAT – A Gift to a Trust with Spousal Access to the Funds.
A QPRT is a trust where the donor transfers his or her personal residence while retaining the right to use the property for a set period of time. A gift tax in the amount of the value of the property minus the retained interest would need to be paid. However, if donor survives the time period and the property is held for the benefit of someone else at the donor’s death, then the value of the property will not be included in the donor’s gross estate. The current low interest rate environment makes the QPRT a good option to use up some or all of your lifetime exemption.
A GRAT is a trust where the donor transfers property and retains right to receive a fixed dollar amount every year. Similarly to the QPRT, if the donor survives the time period and the property is held for the benefit of another individual at the donor’s death, then the value of the property will not be included in the donor’s gross estate. Today’s low interest rates make this an appealing option.
There are two types of charitable remainder trusts. A Charitable Remainder Unitrust (CRUT) and a Charitable Remainder Annuity Trust (CRAT). In both instances, a donor would transfer property to the trust and a non-charitable beneficiary would be given a right to an annual distribution from the trust. For a CRUT the annual distribution would be of a fixed percentage of the fair market value of the trust property for a specific period of time. The annual distribution for a CRAT would be a fixed dollar amount equal to at least 5% of the initial value of the trust property. As long as these trusts are created during the lifetime of the donor, the donor is treated as making a gift of the income interest to the non-charitable beneficiary and the remainder would qualify for the charitable deduction.
Even if the tax exemption decreases before you have used up your lifetime exemption, the concept of “portability” between spouses is still available. Portability is the concept that allows the surviving spouse to use the unused portion of the deceased spouse’s lifetime credit. While the lifetime credit at that time may not be as large as it is now, this is a way to save some estate taxes on the surviving spouse’s death.
Although the outcome of the election and a change in the tax code is still uncertain, there are many ways to start planning for the future now. Clients should begin to think about tax planning tools to take advantage of their lifetime credit before the exemption amount expires in 2025 and while interest rates are low. Before using up this exemption in one of the tools discussed above, an individual should consider the future needs of the family and the consequences of losing access to any funds placed in trust. A qualified estate planning attorney should be consulted to implement a wealth planning strategy that includes any of the above-discussed strategies.
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